Can a bank turn down a UAE resident’s loan application or rather hike up the interest rates if the bank has learnt that the applicant belongs to a company that has been persistently slashing salaries because of COVID-19?Moreover, how does a pay cut affect the debt profile of a person who has just applied to the bank for a loan? What should UAE residents keep in mind when approaching the lender after a pay cut?
With tensions running high this pandemic, there have been complaints among residents about their credit rating being affected after a pay cut, and whether banks are within their rights to charge higher rate of interests on loans for applicants in such dire circumstances or are they being exploited?
Gulf News set out to untangle the perspectives from both sides – the residents and lenders – and simply debunk some concepts that may have been misconstrued or misunderstood, if it has been. However, before going ahead, it’s vital one understands a few simple rudimentary concepts surrounding your debt profile, often known by their seemingly complex names – ‘credit score’ or ‘credit rating’ or ‘Debt Burden Ratio’ or DBR - essentially calculations made to analyse whether you are eligible for the loan.
Key metrics to know first hand
A credit score, also known as your credit rating, is a number that reflects the likelihood of you paying credit back. Lenders like banks and credit card companies will look at your credit history when they calculate your credit score, which will show them the level of risk in lending to you.
Similarly, a DBR is a mathematical ratio or a percentage that is used by banks in the UAE and around the world while carefully deciding whether or not your application is eligible for a loan. To put it simply, it’s essentially what proportion of your salary you are legally mandated to be used to pay off your loan. In the past, banks in the UAE would approve of loans even if the DBR was around 65 per cent. Only anything higher would be either rejected or reviewed thoroughly. However, because of this leniency, many applicants couldn’t repay their debt which then lead to banks undergoing huge losses.
Now, as per the current UAE law, the Debt Burden Ratio has been reduced to 50 per cent. It protects both the payee and the lender better. This way, you aren’t overburdened by the debt amount, too. Now that these concepts have been explained, let’s return to our earlier dilemma of whether you need to be aware of any interest rate hikes the banks can charge you if you have had your salaries cut by your employer.
Can a bank charge you higher interest rates after a pay cut?
Let’s say you approach a bank after your salary was slashed more than once in the past nine months or for several months during the pandemic. Can the bank charge an interest that is higher than the rate that would have been charged before the pandemic-related pay cuts?
The answer is yes they can, but this, for one, purely depends on how your DBR is affected as a result of your pay cut. And secondly, if the employer you work for has had a history of pay cuts and whether the company’s credit rating (not your own) has dropped as a result.
Putting it in perspective with an example
Let’s say you have had a monthly income of Dh15,000 and you’ve been using a total of about Dh5,000 to pay off monthly recurring loans, this can be a car loan, personal loan or credit card debt. This would imply your DBR is 33 per cent, which is well below the legal limit of 50 per cent – but keep in mind it is not as good as another applicant who has a DBR of, let’s say, 25 per cent.
Keep in mind that the bank would been keen to offer a better interest rate to a person with the 25 per cent DBR, compared to you, given that they are taking on lesser risk to loan money to the second applicant. It also depends on your history of paying back your loans on time, which is your credit score.
Now let’s further say that your pay cut has been cut by 30 per cent during the COVID-19 crisis and your salary was cut from Dh15,000 to Dh10,500. What happens is your DBR has now risen to 47.6 per cent. While that is still below your 50 per cent threshold, and you can still avail the loan, the bank now won’t be able to give you the same interest rate as before, given that they will be taking on much higher risk, as the chances of you not being able to pay back the loan has risen further.
Pay cuts don’t affect your rating, but your chances
Let’s keep in mind that while this has not affected your credit score or rating, which is purely an indicator of your history of paying back existing loans, it has affected your capability or ease of paying back any loan, which every bank factors in when approving you an amount for a certain number of months, or as legally mandated to.
This can affect how much the lender lends to you, the amount of the loan, how long the lender can lend you the amount for and at what interest rate they can charge you for. Although it is up to each bank’s discretion on the details, they are also given a set of central bank mandated guidelines on the extent of the flexibility shown. Simply put, banks have been legally obligated to charge a certain interest rate (amount or tenure) to you purely on your DBR percentage.
Banks research on your employer as well
Now there is one other factor banks consider when deciding how much loan should be approved and at what rates – and that is your employer. Let’s say your employer has had a good history of paying you on time and has never cut the pay of their employees.
The bank would show leniency to such a customer when it comes to interest rates, compared to let’s say, an employer who has persistently cut pay. This affects the credit rating of the company and in turn affects how much loan can be availed and how much of an interest rate can be offered to you. Banks assign a grade or something equivalent to each company in the UAE, and a history of pay cuts or salary deferments affects the rating of the company. Each grade, in a way, allows you a set amount of interest rate, tenure or loan, logically speaking.
If the bank downgrades credit rating of the company, or places the company at an ‘at-risk’ category, your interest rates are in turn affected as well. Let’s say pre-pandemic your company had the highest rating, but by consistently keeping salaries low, they have put themselves at risk of lowering their credit rating set by banks. And this in turn affect your chances of availing a loan at a certain interest rate, like you did before the pandemic.
When an employee of such a company approaches the bank for a loan, it’s not just his or her credit score that is taken into account, but also how the employer has fared in the past few months of the pandemic as well. So if the employer has been downgraded, the interest rates availed to you become higher. It’s unlikely there’s a uniform set of guidelines all banks must follow on how many months of pay cut changes the lender’s grading or rating on your employer, as it’s always been left to the discretion each lender to take a call based on a case-by-case basis, which is why offered-rates differ when you approach different lenders in the country.
So what’s the verdict and what should you be aware of?
If your company has been persistently cutting salaries consistently, you need to be able to prove to the bank that you are reliant despite the circumstances, by either showing a history of paying back your loans on time or proving to the bank of additional means of income that can help ease the pressure.
Steps to take before approaching the bank
Before you head to the banks, experts suggest doing a bit of homework, so you know exactly how much personal loan you can and should apply for. According to UAE Central Bank regulations, banks cannot offer a personal loan in excess of 20 times an individual’s monthly salary. So, if you earn Dh10,000 a month, the maximum personal loan you would qualify for is Dh200,000.
• Check your credit report
If you have an existing loan and credit card or have repaid a loan or credit card in the past, it would be best to check your credit report before you apply for another loan. Go through your report to see if all your old repayments have been correctly updated. If the report is missing something, you could end up being offered a higher-than-average interest rate and a lower personal loan amount than what you ideally qualify for.
If one has multiple loans and credit cards and is not clear about the total debt burden, individual credit reports can be obtained from Etihad Credit Bureau on a payment of Dh100 fee. The credit report lists all your liabilities and highlights any missed payments.
• Checking individual credit scores
Individual credit scores are assigned by Etihad Credit Bureau based on the financial discipline of an individual on a scale of 300 to 900 reflecting the risk of default. This score is now an important eligibility criteria for loan products. A score below 400 is most likely to be turned down by most banks. Once all these factors are sorted and you are found eligible, there are some basic documents required to apply for a personal loan.
• Opt for the ‘salary-transfer’ variant
Most banks in the UAE offer two variants of personal loans – One, where the applicant must transfer his or her salary to the lending bank, and the other, where there’s no salary transfer requirement. If you go with the salary-transfer option, you would not only be able to get a much lower interest rate, but will possibly be able to secure the maximum loan amount offered by the bank.
• Consider getting a co-applicant
Some banks offer you the option of applying for a loan with a co-applicant. This can increase your loan eligibility, by taking into account the income of your co-applicant as well. The co-applicant could be your spouse or close family member. And this personal loan option is a good one if you have a low income, a less-than-great credit score or existing debts that have lowered your borrowing capacity.
Checklist before applying for loan
• Applicant should have the latest salary certificate that specifies his monthly salary including all allowances.
• Most banks require the applicant to have completed six months of service with the company to be eligible for a personal loan
• Most banks have a minimum salary requirement starting at Dh3,000. It could vary for different banks.
• Banks will need a salary assignment letter from the employer. The letter needs to be in specific formats drafted by the banks. In most cases, the letter requires companies to make an undertaking to transfer the monthly salary and end of service benefits to the bank in the event of the employee leaving the job.