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The ABC of car finance
Larissa Fernand |
November 22, 2004
ave job. Want car.
Life is rather uncomplicated sometimes.
Even the variety of choices available in the auto market is not a deterrent.
You figured out what you wanted.
The catch is: How you are going to finance your new mode of transport?
Before you go on a loan hunt, get the low down on what's on offer:
Margin Money Scheme
This is a straightforward scheme. You pay a little and the financier (which could be a finance company or a bank), pays the rest.
That means they will pay anywhere from 70% to 90% of the cost of the vehicle (depending on your negotiating skills and their policy).
High end vehicles like the Mercedes Benz will fetch a finance of up to 70% of the cost. But this could go up to 90% for, say, the Maruti 800 or the Maruti Esteem.
The balance amount (the margin), is the down payment. That has to come from your pocket.
How does the MM scheme work?
Assume the finance company agrees to pay 70% of the cost towards buying your chosen vehicle. You will have to pay the remaining 30% out of your pocket upfront to the dealer.
You will be charged an interest on the 70% which you borrow. The interest rate will range from 7% to 15% (second-hand cars carry a higher rate of interest).
You also have to repay this amount over one to five years, depending on the deal you have struck.
How do you do that?
You pay the finance company a fixed amount each month. This fixed amount is called an Equated Monthly Installment (EMI).
Each EMI comprises of the interest and the actual loan amount. Which is pretty much the same method that a housing loan follows. This amount is fixed at the start.
So if you have borrowed Rs 4 lakh and have to pay it back over 3 years at a 5% per annum interest rate, you will have to pay Rs 12,240 every month for the next three years. This is your EMI.
So now you have 36 EMIs to pay up over 36 months.
Advance Installment Scheme
The Advance Installment Scheme offers you two options:
1. You pay the margin amount along with one EMI.
This means you don't pay 36 EMIs like the above. You pay only 35 EMIs.
Because you pay 1 EMI with the downpayment.
When the financier offers this, he will usually ask for a lesser downpayment of, say, 15 percent, as opposed to 20 percent(see table below). This way, you don't end up paying a huge downpayment.
2. You do not make any downpayment. The financier pays the full cost of the vehicle.
Sounds great, right?
But he will make you pay a number of EMIs right away. This could be around 3 to 6 EMIs. This is also called the Multiple Advance Installment Scheme.
So which one is best? Take a look at the table below.
Let's say you want to buy a car that costs Rs 5 lakh and you want to pay it back in 3 years. The financier tells you he will charge you 5 percent per annum.
This is how he works it out:
Value of vehicle = Rs 5 lakh Rate of interest = 5% Repayment tenure = 3 years |
| Margin Money (20%) | Margin Money (15%) and 1 EMI | Multiple Advance Installment |
He will only pay | Rs 4 lakh | Rs 4.25 lakh | Rs 5 lakh |
You have to make a downpayment of | Rs 1 lakh (20%) | Rs 75,000 (15%) | 0 |
Every month you pay (EMI) | Rs 12,240 | Rs 13,005 | Rs 15,300 |
What you end up with |
Upfront payment | Rs 1 lakh (margin amount) | Rs 88,005 (margin amount + 1 EMI) | 91,800 (6 EMIs) |
EMIs you are left with | 36 | 35 | 30 |
The result | § The most number of EMIs § Lowest EMI amount | § Least upfront payment | § Least number of EMIs § Highest EMI amount |
So ask yourself:
~ Do you want to pay more money upfront?
~ Do you feel better paying off the loan before 3 years?
Decide which is best for you accordingly.
Zero-interest rate scheme
This is the most tempting of all auto finance schemes.
You can pay for the car in installments with absolutely no rate of interest. This scheme is promoted when the car financier has a deal with the manufacturer for a particular model.
There could be some catches, though:
1. The repayment tenure may be rather hurried, probably just six months to a year. That means a high EMI.
Ask yourself: Will you be in a position to spare that amount every month?
Assume your car costs Rs 5 lakh. The financier decides to give you an interest-free loan for Rs 4 lakh and tells you to pay Rs 1 lakh from your own pocket.
The balance Rs 4 lakh will be divided between 12 months.
So your EMIs will be Rs 33,333.
Can you afford to pay this amount every month?
2. The financier may also tell you to pay 1 EMI with the downpayment. That means you will have to add Rs 33,333 to Rs 1 lakh. Can you afford that upfront?
Also add documentation fees. Assume you are being charged 2% of the loan amount (2 percent of Rs 4 lakh). That means you will have to pay an additional Rs 8,000.
3. The third possibility is that the amount financed may be rather small (since the financier is not making any money by way of interest, he won't give you the best deal).
So instead of the usual 70 to 90 per cent finance, it may drop to 50%.
That means you will have to cough up Rs 2.5 lakh to pay upfront. Add processing fees (2% of Rs 2.5 lakh) and you have to pay an additional Rs 5,000.
Security Deposit Scheme
Under this scheme, 100% of the vehicle's value is financed.
This way, if the car costs Rs 5 lakh, the financier will pay it all.
But the customer is required to keep a refundable security deposit with the financier. This operates just like a fixed deposit.
How much will the deposit be? It will vary from 15% to 35% of the total amount.
So if the financier asks for a security deposit of 35% of Rs 5 lakh, you will have to give him Rs 1.75 lakh. He will put it in a deposit and return it to you when you repay the entire loan amount.
In some cases where the financier feels the customer is not earning that well to afford the car he is buying, he will err on the side of caution. He will tell the customer him to give him the entire amount as deposit.
So the customer will have to give him Rs 5 lakh as deposit. This money will be put away by the financier. He will put it in a fixed deposit and return it, along with a rate of interest, when the loan is repaid.
Assume you take a Rs 5 lakh loan and agree to repay it over 3 years.
The financier says he wants a deposit of the same amount. So you give him Rs 5 lakh.
The financier will offer you, say, a 3% per annum on this amount.
At the end of the three years, he will return the Rs 5 lakh you gave him along with the interest earned.
Meanwhile, you will have to repay the loan in the form of an EMI every month.
So on a Rs 5 lakh loan, at a 5% rate of interest, you will have to pay Rs 15,300 every month for the next 3 years.
After 3 years, when you have finished paying the loan, the financier will return the Rs 5 lakh that he put in as a deposit and whatever interest rate was earned on it.
The logical question is: If you can spare the money for the entire amount, why not just pay for the vehicle?
Look at it another way. Why part with Rs 5 lakh on a car? Instead, why not invest the Rs 5 lakh? Earn a regular interest on it. Pay your car loan back slowly.
Look out for how to get a good deal on your loan tomorrow!