Dubai: Did you know the larger your bank balance is, the better your chances are at getting a larger loan? It's true, and this is why it's often been flagged as important to meticulously save before applying for big loans, particularly a home loan or a mortgage.
”Most lenders worldwide want to see even more money stowed away in your saving accounts before granting you a loan for a certain amount,” explained Anil Pillai, a consumer banking analyst based in the UAE.
“Aside from wanting to know whether or not you have enough money saved to cover at least some of your future monthly payments should you unexpectedly suffer a financial setback, you also increase your chances of getting better loan terms if you have an ample amount stashed aside.”
Pillai further detailed how saving up and paying in cash essentially makes it possible to negotiate a better price, or at least better financing terms. “This also offers the lender assurance that they are taking on lesser risk when granting you the loan amount, chiefly when it comes to repayment,” he added.
“However, use of such larger credit amounts may make more sense for a larger purchase, especially if it's something that appreciates in value, like a home – or if it means you avoid having to withdraw from a savings or investment account.”
Although savings account interest rates are not particularly attractive at this time, any interest coming in is better than interest going out, making saving at least modestly preferable to going into debt
Is it prudent to save more for borrowing more?
The question of how to pay for a large purchase is tied to a series of personal finance choices. While experts believe they should save up before buying to avoid debt, they also flag how there is actually no easy, one-size-fits-all answer to the question of applying for a larger loan versus using savings.
“At times you are forced to wait until you can buy just because your financial situation won’t allow you to take on more debt, but even if you can finance a sizeable purchase, it may be better to put it off until you have the money in hand,” said Mirin Raul, a Dubai-based debt advisor.
‘”Cash upfront’ is a tried-and-true bargaining tool with a long history. Although savings account interest rates are not particularly attractive at this time, any interest coming in is better than interest going out, making saving at least modestly preferable to going into debt.”
So when planning to purchase big-ticket items, like a car or a house, Raul added how saving for a down payment (or a bigger down payment), allows you to get a smaller loan and reduce the overall cost of borrowing.
“When interest rates are low worldwide, it's usually better to borrow the money. Dipping into savings will cost you some earned interest, and when mortgage and consumer loan rates are low, it can work in your favour to borrow the cash. Your savings are long-term,” added Raul.
“Why most require at least two months' reserves is because this makes it less likely that you'll default on your loan. Lenders aren't just worried about the money you'll need to cover your principal mortgage balance and interest, either,” added Pillai.
“As most homeowners pay additional funds each month to cover their homeowners' insurance, lenders want to make sure that you've saved enough to cover these expenses, too. So if your monthly mortgage payment totals Dh2,500, you'll want to have at least Dh5,000 stashed in savings.”
Banks also check if your savings is ‘seasoned’ aptly
Lenders also want to see that the dirhams in your savings account are ‘seasoned’. What this means is checking whether the money has been in your account for at least two months before you apply for a major loan like a mortgage.
For example, when you apply for an exceptionally large home loan, the reason why a lender will ask for copies of your last two months' worth of bank statements is to ensure buying the home won't be a financial burden for you later and you have a strong standing to pay your mortgage on time.
“Don't deposit a large sum of money into your savings account just before you are ready to apply for a mortgage or a home loan. If your lender sees that this, it will ask you to verify its source,” cautioned Raul, when explaining how it helps to know how banks gauge your borrowing capacity.
“Lenders want to see an established history of healthy savings habits of those who are looking for a home loan. If a large amount of cash suddenly appears in your bank account, it doesn't speak to your ability as a borrower to save responsibly.”
Lenders will count anything that you must pay back, including a loan from a friend, as debt. If you have too much debt, you might only qualify for a smaller loan — or you might not qualify for one. For a mortgage, you are required to save a down payment of 20 per cent of your home's price.
“Closing costs are expensive, too. Let’s say yours is Dh3,000. Unless you can convince the sellers to cover these costs, or get them rolled up into your mortgage loan, you'll need to save these dirhams separately, too,” noted Pillai.
“As it's easy to forget when buying a home that mortgage lenders want to see additional savings beyond the typical down payment and closing costs, this is why it’s vital to work on building a large cash reserve before taking the plunge and applying for a mortgage.”
The bottom line is when it comes to choosing a loan for you, it is not just about knowing how much you need, but how much savings you have, and the larger your bank balance is, the better your chances are at getting a larger loan. This is also where your debt-burden ratio (DBR) comes into play.
Your DBR is the ratio of your total monthly outgoing payments (including instalments towards your loans), to your total income. This number is used by banks to calculate your eligibility for loans as it shows your current liabilities and your ability to pay back.
As a general rule, borrowers should aim to spend no more than 35 per cent to 43 per cent on debt, including mortgages, car loans and personal loan payments. So if your monthly take-home pay is Dh4,000, for instance, you should ideally keep total debt at, or under Dh1,720 each month.
As per UAE Central Bank norms, your DBR ratio must not exceed 50 per cent to be eligible for more. Put simply, you can only use half of your income to pay towards your debts. “Aside from a lower DBR, building your savings before taking a loan lowers your risk as a borrower,” added Pillai.
“If you are a high-risk borrower, most lenders will not allow you to borrow to your limit. So they complete a full assessment, which takes into account more than your income. So your credit history, score, savings and employment will all be considered in the lenders' final decision.”