Not able to make loan payments? How to determine whether you should put your dues on hold

Not able to make loan payments? How to determine whether you should put your dues on hold

Why, if you have the resources to settle debt, asking for a loan deferral isn't cost-effective

Dubai: On Monday, the Central Bank of the United Arab Emirates gave borrowers who were having financial difficulties due to the recent weather in the country the chance to suspend their monthly payments for a maximum of six months, provided that they first checked with their banks and insurance providers.

Loan deferments, sometimes known as "repayment holidays," are a popular substitute that let you temporarily stop making loan payments with the lender's consent. However, when should you think about selecting the option? Is doing so usually financially advantageous? Banking professionals in the UAE assess.

"Delaying your payments may assist maintain the good status of your accounts while you recover, even if it's just a temporary fix. But not everyone would be able to take advantage of this option, as Abbud Sharif, a Dubai-based expert for the banking sector, clarified.

Banks primarily provide this option to customers who are having financial difficulties, allowing them to put a temporary stop to their loan payments. One example of this is the 2020 pandemic crisis, in which people throughout the world found it impossible to pay their monthly bills owing to job losses or wage reductions.

Normally, how does a loan deferment operate?

While interest may sometimes accumulate throughout the stopped term, a deferral period is an agreed-upon period of time during which a borrower is exempt from paying the lender interest on the borrowed amount on a loan. This implies that after the deferral period ends, the interest is applied to the total amount owed.

"Interest capitalization" is the process of adding arrears to the principle balance—the amount you borrowed—of your loan. When payments are delayed during times of deferral, the principle amount of a loan rises and unpaid interest is "capitalized."

However, there are certain situations—student government loans in the US, for example—where interest does not accumulate during such times. In addition, interest did not accumulate during the loan deferral period during which the COVID-19 pandemic affected borrowers, nor would it do so under the recently announced loan pause option in the United Arab Emirates.

The majority of other loan deferrals come with interest.

"When lenders grant such a waiver on borrower debts, many of them postpone their loans even though they can currently make their payments, believing they can take advantage of this opportunity to obtain a temporary reprieve on their monthly debt payments," Sharif said.

However, this isn't the best concept as one could believe. When deciding whether to delay a loan, banks consider each borrower's capacity to repay as well as any interest that may have accumulated during the stopped time. Most people overlook this, which is why many of them act quickly to take advantage of loan deferment possibilities.

This implies that your loan total will continue to grow each month due to the interest you accumulate when you aren't making payments. Therefore, before we continue, please realize that this is really a grace period and not a debt discharge.

Assume you have a Dh729 monthly interest payment on a Dh350,000 mortgage or property loan. The monthly interest on your loan will continue to accrue at this rate, which is known as "capitalizing" the debt.

What happens if interest on a debt builds up?

In the event that you fail to make your monthly loan installment payments (EMIs), banks are often required to impose interest on the outstanding balance. A banker in Abu Dhabi named Jose Paul indicated that missing two installments may lengthen your loan by six to ten months or raise your monthly installment amount by around 1.5%.

"On the other hand, a deferral should on prolong the loan by the number of postponed installments in a typical real-world EMI situation. EMIs include primary components as well as interest. Therefore, interest capitalization and payment schedule reformatting won't be necessary for certain deferrals.

However, there would be consequences for rate changes if the borrower chooses to restructure the loan, which would include changing the duration and EMI. Alternatively, if you decide to take a repayment vacation, your minimum payments after the repayment pause will be larger and you will ultimately pay more interest.

"Only put loans on hold if absolutely necessary."

Paul and Sharif both agreed that debtors should only put debts on hold if absolutely necessary. "Remember, the influence increases with the remaining term. This is because interest gradually reduces over time, making up a higher share of the EMI in the early years, Sharif said.

But it's crucial to remember that interest costs make up about 80% of the EMI after the first year. However, as your long-term loan draws to an end—let's say after 20 years—the interest component of the monthly interest payment (EMI) drops to less than 10%.

Put otherwise, a person who took out a loan, say, ten or fifteen years ago, won't feel the weight of it as much as a person who took out a fresh loan just a few years ago. This suggests that borrowers who have older loans may not really need the moratorium to the same extent as borrowers who have younger loans.

Thus, choose deferment only in cases of extreme need. Avoid choosing the moratorium if you are able to make the EMI payments. Remember that banks function like any other company, so skipping repayments is unsustainable, Sharif added, if you're wondering why interest is still accruing and not eliminated.

IF I WANT TO ADVANCE AND GET MY LOAN DEFERRED FOR A FEW MONTHS, WHAT ARE MY OPTIONS?

Lenders will probably offer borrowers the following choices, while the details may differ throughout banks:

• If interest starts to accumulate in April and May, the borrower has the option to make a single payment in June.

• The interest is applied to the remaining loan balance, raising the monthly installment amount for the remaining months.

• The loan term is prolonged but the EMI remains the same. The length of the loan will then determine how many further EMIs are required.

In summary?

If you're having trouble paying your debts, there are other options than just pressing stop. In order to get through difficult circumstances, you might potentially temporarily lower your payments as an alternative to deferring the whole loan payback. Reducing or stopping your payments could help you stay out of default, Sharif said.

If you are making your payments on schedule, you may sometimes be able to access cash in your redraw facility. Another way to lessen financial strain is to temporarily switch to interest-only payments.

Financial experts often advise against asking questions about deferments if your financial circumstances haven't altered. "Leave your lender's resources free for those who need them; banks will do everything in their power to assist those in genuine need," said Sharif.

It's also critical to understand that you won't always have the option to put your loan on hold. The lender has the last say on whether to grant a pause. Since banks are companies, they must consider the risk of granting a pause to clients who are unable to repay a loan over the long term," Paul said.

If your bank agrees to a loan pause, you will experience temporary respite. But you definitely need to have a longer-term financial strategy than six months if your circumstances don't alter. This is due to the fact that there isn't presently any discussion about extending this leniency period above that point.

The most important lesson here is to constantly tell your bank of all the details of your financial situation, especially if you are having trouble making your repayments, and to inquire about any possible help.