Keep your car loan in the secure zone
Your dream car just got costlier in 2011, thanks to rising interest rates. But should you postpone the decision to buy a new car?
Not if you have been saving up for 2-3 years. It is definitely not the best option to bank highly on a car loan. Ensure you cough up at least 30% of the cost of the car even if banks insist only on 15% of the cost as margin money.
“Car loans are bad because the value of the car depreciates faster than the principal amount,” says Kartik Jhaveri, certified financial planner, Transcend India. You should set their financial goals much in advance and plan properly to achieve them. Give priority to your needs over wants. You should always consider safety features, maintenance cost and fuel efficiency but should not pay extra for luxury if you cannot afford it. That doesn’t mean you should not take a loan. But keep the loan amount as low as possible and fund the purchase out of your savings.
Ensure that the EMI does not exceed around 25% of your monthly income/salary. The loan amount should be decided on the basis of your affordability to pay the EMIs and not just by what banks offer,” says Pankaj Mathpal, certified financial planner.
Avoid taking a loan for down-payment. The average loan-to-value ratios quoted by banks tend to be in the range of 80-85 % of the ex-showroom cost of the car. That implies you have to pay up to 15% of the car value out of your own pocket. However, percentages could vary, depending on the vehicle segment.
Banks quote only rack rates. But the actual interest could be much lower, depending upon subventions and other dealer discounts.
The problem here is that auto loans always work on subventions, which vary from dealer to dealer. So, it becomes difficult for a borrower to scout for the cheapest rate in this scenario. Ideally, a borrower should fix the car model, know the price and fix the loan amount. Once a borrower knows the exact loan amount, he should approach the dealers who also act as DSAs for auto loans. “Any customer should ask only for cash discount.
Most dealers confuse the customers by saying they will offer a lower interest rate instead of a cash discount. But car buyers hardly know how to calculate the actual internal rate of return (IRR). Hence, if a borrower is paying . 1 lakh as the down payment for a . 5-lakh car loan, s/he should ask for a cash discount on that . 1 lakh.
“Fixed rates are more popular as they avoid any effect of cyclical changes. Also, these are more transparent,” says HDFC Bank’s Khanna. Since 2007, banks have started offering floating rates in car loans as interest rates increased by almost 1-2 % in one year. Unlike home loans, banks offered car loans at a fixed rate for the entire tenure of the loan. Home loans also offer fixed rates but with a reset clause.
As per that clause, the bank has the right to change the interest rate once every three or five years as stipulated in the home loan agreement. “But car loans do not come with this clause. Moreover, unlike home loans, the difference between a fixed rate and floating rate is in the range of 0.5-1 %. “In India, borrowers have always faced the upside risk in floating rates.
But they have never experienced the advantages of floating rate even when interest rates start falling. Hence, the difference of 0.5% doesn’t pinch much. Clearly, the advantages of a fixed rate outnumber that of floating rate in car loans. In fact, borrowers can breathe easy by betting on a fixed rate in a rising interest rate regime.
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