Manage your debt

 

Over the next few months Andrew Prince, Financial Planner, Acuma plans to cover a number of aspects of financial planning, to hopefully build what will optimistically be a useful financial fitness plan. In much the same way as when you go to the gym and start a physical fitness plan, you will not see results immediately, but over the course of weeks and months, by sticking to your plan, the benefits will start to show.

 

Your financial health is in fact very similar to physical health – a lot of people become disillusioned when they do not see immediate results, or suffer a setback, but the key is to stick with the plan and carry on building for the future. This month I will cover debt, some of the key things to be aware of and the best way to manage debt. Unless you are very fortunate, most people will use debt during their lives. Debt itself is not a bad thing, as long as it is used and managed correctly. It can easily get out of hand if not carefully monitored. For large purchases such as property, debt is often used and referred to as a mortgage.

The interest rate in general is relatively low for this form of borrowing, as the debt is secured by an asset. For instance, the house you are buying; so the lender is confident it will make money over the long term and it has control over the property if you should stop paying back the debt.

The property market in the UAE has seen a recovery over the past year or so, encouraging more people to consider buying property. The Central Bank has been looking at ways to try and control the market. One way is to cap the borrowing limits available to purchasers forcing them to put down a reasonable deposit which along with the increased transfer levy, should reduce the amount of speculators or ‘flippers’ creating artificial demand. Where many people can quickly get themselves in difficulty is with unsecured debt, such as credit cards and personal loans. These forms of debt have a higher interest rate applied to debt because the lender has nothing to hold as collateral. The loan is often over a shorter period of time and if I am being brutally honest, the lender penalizes the borrower for their lack of prudent saving. Using a credit card as an example can be an effective way of earning air miles and maximizing the amount of interest gained on what savings you do have.

Where it goes wrong however, is when you fail to pay off the whole debt each month. Interest will be charged on the whole amount from day one, irrespective of what you have repaid and the interest rates on credit cards can be up to 40% per annum. Many people I meet do not realize this as it is likely to be shown as 2% per month on the statements thereby obscuring the headline figure. You may not realize the true cost of the borrowing and then over time the debt builds up to a point that it is difficult to repay. I would encourage you to search out on-line calculators that demonstrate how long it will take to repay a credit card if the minimum payment is made each month. The results are frightening, often running into a decade or more. Looking at a couple of terms that you often see quoted after interest rate numbers; the first is the flat interest rate – this is an interest rate calculated on the basis of the stated initial principal amount of the loan irrespective of the term of the loan. While the Annual Percentage Rate or APR is the annual rate that is charged for borrowing, and expressed as a single percentage number that represents the actual yearly cost of funds over the term of a loan. This includes any fees or additional costs associated with the transaction. The APR is generally a higher number and is a much more accurate measure of the cost of any loan.

This is a brief summary of the debt situation, and next month we will look at wills and other protection solutions.

 

About Andrew Prince:

 

Andrew Prince is a Financial Planner at Acuma Independent Financial Advice. With a technical background, Andrew uses his 20 years’ experience as a Financial Planner for the benefit of the client. Holding the Chartered Insurance Institutes Advanced Financial Planning qualifications, Andrew has been helping clients in the Middle East since 2010. Previously, he ran his own FSA-authorised company in the UK specializing in investments, particularly in conjunction with trusts and estate (tax) planning.

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