With India’s growing economy coupled with a growing number of salaried individuals with disposable incomes, the demand for all sorts of luxury goods is on the rise. Among other things, the sale of premium automobile variants is seeing a major boost. Banks are fuelling this penchant for aspiring automobile owners by gladly extending loans at seemingly attractive terms to individuals from all walks of life.
Additionally, technology has become a game changer in the lending industry. While online aggregators are assisting people in seeking, comparing and applying for economical loans, banks are approving and disbursing loans in record time. Car makers are also taking advantage of the liberal car loan regime and introducing multiple variants of their cars to cater to a wider group of people. Some of the key features available in the premium variant include power locks, dashboard monitor, additional security features like air bags,
However, it is always better to avoid getting carried away and remember these tenets of prudent borrowing:
Don’t bite off more than you can chew
As this age-old adage warns, a key rule of smart borrowing is to only take a loan that you can repay without stretching your finances. A general thumb rule is that car loan EMIs should not exceed 15% of your net monthly income.
Scout for the best interest rates from as many banks as possible, and keep yourself updated about changes in rules and rates to ensure you benefit from the loan to the fullest. Take into account charges such as processing fees and pre-payment penalties before making your final decision.
Despite this, if buying that top-of-the-line car model is going to leave you broke or in financial distress each month, – think again. Use easy to use tools such as the car loan eligibility calculator to determine the loan amount that would balance you needs with your requirement.
The 20% approach
Even after adequate research, you may find yourself in a dilemma about how large a car loan must be taken. You should always remember that no matter how swanky the car, it is still a depreciating asset i.e. the value of the car decreases over time. Bigger the car loan you take, the less judicious you are being. Also, bigger the car (and therefore the loan), higher would be its overall maintenance, fuel, servicing, repairs, insurance costs.
Several studies conclude that ensuring a car loan does not exceed 20% of your monthly income is a prudent practice.
If your monthly income is Rs. 25,000, your car loan EMI should ideally not exceed Rs. 5,000 each month. If your EMIs eat into a big chunk of your monthly income, other critical goals like your annual investment goals, children’s education/marriage, your retirement savings, etc. will be impacted. Getting a car loan may be a breeze, but to enjoy your new car and comfortably pay the EMI, maintaining this 20% ratio is definitely a good idea. Additionally, take into account that this 20% amount is contingent on your having no additional liabilities such as loans to take care of.
Up to 85% of the vehicle’s value is usually given as a car loan, and in doing so, the borrower’s repayment capacity is taken into consideration. Now if you have your mind set on that latest BMW, ensure your monthly income is substantial enough to support the EMIs.
Don’t get up-sold by a smooth talking salesperson
Apart from the cost of the car itself, a car purchase involves miscellaneous expenses like registration and documentation fees, sales tax, insurance, etc. Dealers rely on their service departments and other ancillary services to sell a bunch of extras to car buyers.
Apart from the car itself, a dealer also profits from the financing of the cars, hence dealers push you to take advantage of their financing options. Additionally, car salespeople pitch add-ons like extended warranties, gap insurance, rust proofing, undercoating, etc. Assess if you really need these before being talked into such add ons.
Remember you can easily buy any of these add-ons later from another authorized service provider/dealer and are under no obligation to decide right then and there. Do not get discouraged by the dealer telling you that you cannot roll these extra costs into your loan – it is just a tactic. You will unnecessarily be increasing your loan amount without any real increase in the value of the car you are borrowing for.
Expanding your car loan terms can contract your bank account
Shorter loan terms come with higher EMIs but lower interest rates. A longer loan term is nothing more than a visual delight – it ‘appears’ to offer savings in your EMIs, but costs a lot more in terms of total interest payable and this adds to your car loan tenure.
Start with credit score clarity
It is crucial you understand your credit score before taking a car loan. Unlike credit cards, personal loans or mortgages, a car loan may be given even to those who do not have a great credit score. Not such great news, because the ease in getting this car loan may be offset by the amount you pay for it. One of the reasons why it is easy to get a car loans is because it becomes relatively easy for banks to repossess the car if you fail to pay.
For those who know their creditworthiness is not the best, getting a loan feels like an achievement. Often they do not cross check if a lower rate can be availed. Car dealers know and use this to their best advantage. It is best you find out your credit score and check if you qualify for a better interest rate on car loan.
Dealerships often advertise unbelievably low interest rates on new car purchases, sometimes even 0%. What they don’t advertise is that these attractive rates are only for buyers having the best credit history.
Before signing your car loan, remember:
- Putting at least down 20% of the total car price towards down payment lowers the total amount you need to finance for so start saving for your car ahead of time.
- Apply for a car loan with a few banks and ask for the best deal, then ask the dealer to beat the bank’s offer. Don’t be afraid to negotiate hard.
- With an online calculator, use the car’s total cost to run varied EMI and interest scenarios to check figure out what loan tenure you are comfortable with.
- A shorter loan term may be smarter. If your dream car only fits your budget with EMIs stretching beyond a five year term, you are probably shopping outside your affordable price range. Reevaluate your priorities and financial situation, and decide if you absolutely need that trim level, or even that brand.
- Sometimes lender insist you buy an insurance plan linked to the loan, which means a single premium plan that is not cost-effective. Its best to avoid such an option.
- Never make light of your car loan’s fine print. Read all terms and conditions carefully to save yourself from unpleasant surprises later. If you cannot comprehend the legal jargon, get professional help before signing the car loan agreement.
In Conclusion: Once you take a loan, you have to pay it off, sooner or later. Some banks may charge 4%-5% of the total loan amount on prepayment, but majority of banks permit prepayment without slapping a penalty. But the golden rule as always is to borrow within your repayment ability. If you have a financial windfall and you can prepay the loan, go ahead and do it as you would save a fair bit on the interest accrued even with pre-payment penalties.