Understanding the signs: how UAE banks scheme to have expats fall right into a debt trap
How many people do you know who love to preen using borrowed feathers? In Dubai, it is a popular pastime for many expatriates.
A short-term seduction of the good life, this habit sooner rather than later has the feathers coming unstuck leaving the one who preens in dire straits. What abets and aids this predilection is the easy availability of credit cards, loans and hire purchase schemes that lure many expatriates into easy spending and soon they find themselves inside a financial maze which offers no way out for years.
At the peak of the downturn in 2009, many expatriates found themselves saddled with financial liabilities resulting from hefty EMI (Equated Monthly Instalment) they had to part with to pay for fancy acquisitions like fancy cars, jewellery, foreign trips, etc, through personal loans and mountainous credit card bills. Bankers estimate that nearly 2,500 such debtors fled overnight from Dubai alone and there were several luxury cars abandoned in parking lots by these fleers.
So the question is: What makes people in the UAE seek instant gratification and adopt a lifestyle that pushes them to the precipice of financial doom?
Before we examine the reasons, here’s a sobering quote from Calvin Coolidge, the 30th president of the US to mull over: “There is no dignity quite so impressive and no independence quite so important as living within your means.”
Spend what you earn
“It’s a mindset people acquire when they come here,” says Frank Hutchinson, managing partner of Alpha Omega Partnership of Holborn Assets in Dubai. “Expatriates come here to earn money in a tax-free environment and only 20 per cent of these leave with some money saved. It is easy to get credit here as the background check happens only within this country.
You may have left your own home country with a bad debt, but as long as you have a salary, you are entitled to a credit card. People get pulled into flaunting a flashy lifestyle. Having come here, you can even get a rent loan in advance to pay your annual house rent. But [despite these privileges] few people realise that banks will find a way to make money through your liabilities.”
Hutchinson says there is an absence of a regulatory body that has a central data base on people’s net worth, assets and liabilities. This could be useful in preventing people from running wild with their financial worth for their own benefit.
As the situation stands, people ratchet up loans with different bodies. Many expatriates in the UAE are in the habit of possessing six-seven credit cards. When an application is made for a credit card, the process of granting one is relatively simple. The questions asked in the preliminary forms are few and do not attempt to cover the full credit history of the applicant.
With this kind of ease of obtainability, people tend to max out one credit card and shift to another and yet another as their purchasing power meets no obstacle. By the end of a few months, they are paying up collective interest on half a dozen credit cards that amounts to a hefty sum, says Hutchinson.
A simple wake-up call people can give themselves is this, says Hutchinson, Ask yourself, ‘Would I go to a back street money lender and pay exorbitant interest rates in borrowing money?’ If the answer is no, then you need to take yourself to task for succumbing to the high rates of interest levied by banks on these credit cards, he says.
Today, credit cards charge nearly 23-24 per cent interest per annum. And every fils of that interest you are paying is your own money. Except, this money gets you nothing in return.
As a lifelong belief, we should be clear about our financial bottomline, says Hutchinson. “You must not attempt to spend money that you do not possess.”
Hutchinson manages cradle to grave financial planning for his clients and thinks it is absolutely essential to have a plan worked out if you want to be a judicious spender.
Let us look at a few ways how money earned by you works for others.
Your money in the bank
Senior financial adviser and planner with Acuma Amit Mitbawkar says it is important to understand how banks use your money to earn revenue for themselves.
“Banks make a 100 per cent profit on the money depositors keep with them by lending out nearly 90 per cent of the deposited money to others. While the depositor gets nothing but the promise to be paid back in full as and when he decides to withdraw his money.
“If a borrower does not return the borrowed money, does the bank really lose anything? Nothing. In fact they get to repossess the physical and real mortgaged asset like the house or car in return for fictitious money. They also get to sell these repossessed assets below market price, and make 100 per cent profit since the loaned capital never existed in the first place.”
The credit card temptation
What is important is to understand how working class people accumulate debt in the process of living out their dreams where banks call and tempt potential clients with attractive schemes hitched to credit cards that have such cash spend limits that go far beyond the actual pay back capacity. “Since digital currency is virtually limitless, banks encourage borrowing by calling everyone and offering them personal loans and free credit cards with no regard to their ability to pay it back. The onus then lies on the customer to decide ‘when’ and ‘how much’ to borrow. Do not borrow unless you can pay it back in full every month,” cautions Mitbawkar.
Good debt vs bad debt
Yes, there is such a thing. All debts are not bad.
Borrowing to own a home or a car is OK, as long as the total premiums you pay is not more than 20 per cent of your income. But if you get caught in the ‘upgrade culture’ and start taking credit that is more than you can repay every month, you have created the recipe for disaster, according to Mitbawkar.
“Good debt is where you are borrowing to start a business that earns you more than your interest payments or buying a house that you give on rent and earn more than you pay to the bank,” he says.
Bad debt is where you start borrowing for luxury items or indiscretionary spending by giving in to peer pressure. “Once you get into the vicious grip of a bad debt, you begin to accumulate interest where you spend your hard-earned money paying a high rate of interest,” he says. “You might spend Dh100 via a credit card, but end up paying nearly Dh150 owing to the recurring interest rates. Dh50 may not seem much but add all the extras in a year and you will be surprised how much it amounts to.”
The case for debit cards
Although most people find paying through debit cards unappealing (as the money is deducted at source), financial experts encourage this habit because this leads you to spend only the money you have. However, people are psychologially more inclined to pay through credit cards as they lull themselves into a false notion of being able to get nearly a month’s time to pay just a portion of their spend. They believe that they are better off paying small sums over an extended period of time rather than have big chunks lopped off their savings. This mindset pushes them to go on shopping sprees their budgets can ill afford.
Now, let us take a look at how high interest rates trap you into paying more than what you have spent.
High interest debt and its pitfalls
When it comes to credit cards, less is more. The more credit cards you have, the more you spend in paying off interest on your principal amounts. It is one of the biggest myths in the money world that multiple credit cards give you more purchasing power. The purchasing power is at best a superficial benefit. The bottomline is that you are setting yourself up to spend more than you can afford. With every credit card you sign up for, you are extending your debt horizons.
“People start using more than one credit card because the banks offer them for free. What they do not know, or often fail to find out, is that if you do not pay the full amount at the end of the month, the bank will charge you almost 3 per cent per month or 36 per cent per annum,” says Hutchinson.
To know the full extent of how much extra money you have simply blown off on credit card interest, calculate the full amount you have paid to a bank in one financial year. Debit the amount on actual amount that showed on your monthly statement, which is the amount you really spent. The remaining sum is the interest. It’s the extra money you could have saved that year had you paid the full amount at the end of each month.
What needs to be done to curb this trend?
Most expatriates who live dangerously are not really aware of the severity until it is too late. “The most important answer to this question about how to handle money is to first create a thought process about saving money,” says Hutchinson.
However, this attitude is not an instant makeover. Most of the sensibilities regarding money start in childhood. “This should have started with the parents,” says Hutchinson, who lectures sixth form students on financial planning, preparing them for the future. He believes that practising thrift is a habit youngsters need to be introduced to at a young age.
He gives six tips on simple financial planning:
1. The 20-80 ratio.
Start to save money the day you begin earning. The thumb rule? Save 20 per cent of your earnings and reinvest it and live within the remaining 80 per cent of your salary.
2. Take a good look at income and expenditure and work out a budget, Remember, a budget is only as good as how much you adhere to it.
3. Always remember why you left your home country to be here — to strengthen your future. To do that you need to be prudent, build capital and spend as little as possible.
4. Search for a quality financial planner and employ his services to plan your financial future.
5. Always use a debit card as that will encourage you to spend only the money you have.
6. Stop the habit of trying to living up to the Joneses.