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Abu Dhabi, UAEWednesday 17 October 2018

What does a higher interest rate mean for UAE consumers?

An increase has an effect on personal finance products, such as loans, credit cards, mortgages and savings accounts

Illustration by The National 
Illustration by The National 

The Federal Reserve’s decision to raise interest rates last week might not be an event everyone in the UAE followed closely.

But the decision by the US central bank to lift rates by a quarter point, to between 2 per cent and 2.25 per cent - the third such increase this year - affects bank customers in the UAE more than they realise.

This is because when the Fed raises rates, the Central Bank of the UAE generally adopts the same policy, which in turn impacts rates on a variety of personal finance products, from loans to savings and more.

“Whenever the Federal Reserve raises interest rates, the countries with currencies pegged to the dollar, like the UAE, often follow suit,” says Jon Richards, chief executive of the UAE financial comparison website yallacompare.

This is exactly the move adopted by the central bank last week, when it lifted its benchmark interest rate 25 basis points to 2.50 per cent on the certificate of deposits it uses to transmit interest rate changes to the local banking system.

However, Mr Richards says not all banks will apply the increased rate to its consumer products.

“Banks are within their own rights to keep the rates for their consumer products at the same level,” he says.

For UAE consumers, this could mean there is either no immediate effect or that rate changes will only be applied to some of the financial products in their name.

Khatija Haque, head of Mena research at Emirates NBD, says higher interest rates tend to dampen consumer spending as well as investment, as the cost of financing rises. "However, savers will benefit from higher returns on their deposits," she adds.

Higher rates can mean different things to people, depending on where they are in life. In general, for people borrowing money, it means life is getting more expensive. For savers, it means slightly bigger rewards. Here's a look at some of the effects:

Savings

Starting with the good news first, savers will be earning more on their cash - even if it is only by a small margin.

"A potential rise in returns on savings accounts and deposits will help cushion the impact of rising lending rates," says Ambareen Musa, the founder and chief executive of financial comparison site Souqalmal.com. "Along with helping your savings grow, keeping your money in interest-earning accounts will also provide a hedge against inflation and a potential erosion of value if the money is simply stashed away in current accounts."

Mr Richards says those with variable-interest savings accounts, in particular, may find that their money is working better for them.

"Certainly, if you have a large amount of cash in variable rate savings account, you may find that your interest payments go up if and when your bank raises interest rates on its products," he says.

For customers who prefer to lock their savings in a for a set period in a fixed-deposit account, Mr Richards advises waiting to see if banks apply higher rates to these products to secure better rewards.

But with more rate rises potentially on the cards, Mr Richards advises opening a variable rate savings account and watching how far the increases go.

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Credit cards

The average annual interest rate on credit cards in the UAE is close to 40 per cent, says Ms Musa, "easily one of the highest in the world".

With rates already at such a high level, a minor rise is unlikely to have a huge effect, says Mr Richards.

“Of course, if you have large amounts of debt on your credit card and your bank raises its card rates, you’ll end up paying more,” he says. “Most credit card providers will keep their rates at the same level for the time being. However, some providers may introduce different rates for new customers. If you’re an existing customer, any rate change will be communicated to you clearly, well ahead of time – as per central bank rules.”

Rate rise or not, consumers should avoid the slippery slope of credit card debt. With global interest rates now on the rise, carrying a balance is only going to get more expensive. In the US for example, Nick Clements, co-founder of MagnifyMoney.com, a financial information website, estimates the average household that carries credit card debt month to month will pay over $150 in extra interest per year compared with before the rate hikes began.

Ultimately, if you have a high outstanding balance, pay it down as soon as you can to avoid giving more money to the bank in interest.

Ms Musa says a policy of steadily rising rates could see UAE retail lending make a move towards "credit score-linked loans and credit cards in the future".

"For instance, there are specific 'sub-prime' credit cards for individuals with low credit scores in the US that come with higher interest rates, while applicants with a high credit score have access to lower-interest options."

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Loans

If you have taken on a personal loan or car loan and are already paying it off, you have nothing to worry about, as the interest rate applied to your loan will remain unchanged.

“The applicable rates at the time the contract was signed are valid for the term of the loan,” says Mr Richards.

But borrowing could become more costly for those hoping to take out a new loan, whatever the money is intended for.

“Since the banks will now have to shell out additional sums in terms of higher interest rates, there is a high possibility that the interest on loans such as personal, housing, auto etc. will rise as banks will try to counter the downward pressure on net interest margins,” says R Raghu, the chief executive of the research firm Marmore Mena Intelligence. “ Consumers should therefore expect to incur higher borrowing costs in the near term.”

That does not mean every bank will raise its lending rates.

“Some will keep interest rates low to attract customers, while others may offer loans to riskier borrowers but at higher interest rates,” says Mr Richards. “Before you sign on to a new personal loan, be sure to compare other banks’ borrowing rates to make sure you’re getting a good deal.”

And if you plan to take out a loan in the near future, do it quickly. Mr Richards says the banks can take time to implement rate rates, so starting your application process sooner, rather than later, may save you a little bit on interest.

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Mortgages

Lynnette Abad the director of research and data, at real estate portal Property Finder, says the rise in interest rates “is unfortunately not a welcome event” for the sector at a time when it continues to experience a correction in prices, and the government is working to create incentives to boost the market.

For those considering taking out a mortgage to buy a property, higher rates on home loans could be a deterrent. But how you are affected depends on the type of mortgage you have:

• Fixed-rate mortgages

For those locked into a fixed-rate mortgage – where the interest rate is set for a specific period - the latest increase will not affect your current monthly payments, says Ms Abad.

She says the average current offer on fixed-rate home loans in the UAE is 3.99 per cent.

“Interest rates on fixed rate mortgages interest rates are fixed for a predefined period such as one, two or three years. Those on fixed-rate mortgages will continue to pay the same monthly installment until their fixed time period expires,” says Ms Abad.

• Tracker mortgages

Ms Abad says the average current offer for a UAE tracker mortgage is 3.75 per cent.

While this is lower than a fixed-rate product, last week’s interest rate rise means many tracker mortgages will go up by 0.25 per cent depending on who you bank with.

For new home buyers, choosing whether to go for a fixed or variable mortgage can be tricky, says Ms Abad, as it depends on many factors such as whether the borrower is an Emirati or an expatriate, if they are self-employed or salaried or what their monthly salary is.

“For the foreseeable future, it is overall better to lock in a rate as rates are only expected to increase in the next two years and most fixed terms will be one to three years," says Ms Abad.

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Are there more rate rises to come?

Global interest rates were slashed to near zero in early 2009 as central bankers led by the US Federal Reserve battled to ward off economic collapse during the worst moments of the global banking crisis.

What was originally meant as an emergency measure, however, became a long-term monetary policy, lasting several years.

The Fed started the tightening process in December 2015 and now has now introduced eight gentle hikes, with three this year and another expected to come before the close of 2018.

"While a fourth hike at the end of the year is widely expected, it now remains to be seen if the Fed adopts a more hawkish stance in upcoming policy reviews considering that trade tensions with China and rising oil prices are weighing on the global economic climate,” says Emilio Pera, partner and head of audit at KPMG Lower Gulf.

However, some analysts urge UAE residents to brace themselves for more rate increases this year and next.

Khatija Haque, head of Mena Research at Emirates NBD, says: "We expect another 25 basis point rate increase in December with at least another two rate hikes in 2019."