With rising rates and higher prices, it's wiser to save more to lower the loan amount before buying your dream car
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.
Never Go Overboard: Car loans are bad because the value of the car depreciates faster than the principal amount. 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.
It is not only the EMI which will affect your monthly budget but also the cost of fuel and regular maintenance of the car. So 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. Sometimes people opt for a long-term loan of 5 to 7 years to lower their EMI burden. But they should understand that they pay more interest if the term of the loan is longer. You should consider a three year loan tenure instead of five years, if possible. Don't stretch to seven years. Also, 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.
Don't Expect Standard Interest Rates: Banks quote only rack rates. But the actual interest could be much lower, depending upon subventions and other dealer discounts. The bank specifies the rack rate on which it will propose to lend. The dealer has the option of ploughing back his commission, thereby reducing the interest burden for the customer. The decision of the extent of commission to be ploughed back rests with the dealer. Manufacturers also provide subventions, from time to time to ensure stock liquidation, and these may also be passed on to the customer to reduce his effective interest burden. However, the bank will continue to maintain its lending rate.
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. Then he should compare this discount offers by various lenders to identify the best deal
Go For A Fixed-Rate Loan: Fixed rates are more popular as they avoid any effect of cyclical changes. Also, these are more transparent. 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,
Buy Your Own Insurance: Before making the final purchase, you will know the finer details of the car such as the model number, cost and other details. With these specifications, you can do some home-work on car insurance before sealing your purchase. Once you get the premium quotes, you will be able to compare them with insurance deals offered by dealers. There have been cases where customers have paid 30% lesser on car insurance premiums compared to those who have bought insurance from the dealer. Hence, a car buyer should make an informed decision. Moreover, if you are selling an old car which has some NCB from the insurer, you can get it transferred to the new car even if you switch to a different insurer. You have to submit the old insurance document which mentions the NCB (no-claim bonus) on that car. Then, the new insurer will cross-check with the old insurer to authenticate these details and do the needful.
It is never a bad idea to buy a set of flashy wheels for you or your family. There is a certain percentage of income which should be ear-marked for luxuries and a lifestyle. But that shouldn't happen at the cost of savings or come with a huge bill that creates a dent in your personal finances. Plan, save and then splurge.
DRIVING LESSONS
Here are some of the things that you should keep in mind before buying your favourite car:
Ø Fix the car model first, find out the price and then fix the loan amount
Ø Borrow right. Your EMI should not exceed beyond 25% of your salary
Ø An affordable EMI rather than a higher loan eligibility should be the deciding factor If possible take a three-year loan to save on the interest cost
Ø Avoid taking a seven-year loan. It will be wiser to postpone your plans by a year and save up more
Ø Instead of scouting for lower interest rates, ask for cash discounts from car dealers Buy your own insurance and narrow down your options before making the final purchase
Ø Avoid prepaying the loan. Prepayment charges are as high as 5% of the amount prepaid
