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An Introduction to Car Loan / Auto Loan / Vehicle Finance

This article introduces you to various automobile finance options available. It also talks about the factors to be considered while availing a car / auto loan. (Inspired by a query from user: ketankhatu)

With the income levels rising in India, many families have a high disposable income these days. And with high disposable incomes comes an urge to upgrade your lifestyle!

And what can be a better way of upgrading your lifestyle than buying a car? This is especially true since you have so many lenders eager and willing to extend a loan for your vehicle purchase, making the purchase of your dream car so easy…

Since there are so many options available to finance your automobile purchase, lets understand them better so that you can choose what is best for you.

 

Margin Money Scheme / Regular Auto Loan

This is the most basic, and the most popular option. Here, you pay your share of the cost of car – called the Margin Money – and the bank gives the rest as a loan. The margin money is usually 10 – 15% of the cost of the car. Thus, the bank finances 85 – 90% of the cost of the car.

You repay the loan in the form of Equated Monthly Installments (EMIs), which you give in the form of Post Dated Cheques (PDCs).

Tenure

The tenure of this type of auto loan is usually 1 to 7 years, although tenures more than 5 years are relatively rare.

As the tenure increases, the monthly EMI reduces for the same loan amount. Thus, a higher tenure would enable you to opt for a higher loan amount.

But please remember that since the tenure is long, you would pay many EMIs, and therefore would end up paying a lot more in the form of interest compared to a shorter duration loan.

Therefore, choose the tenure depending on your need and your repayment capacity.

Rate of Interest

The rate of interest on auto loans is higher than home loans, but is normally lower than personal loans. The rate of interest for loans of longer duration is usually higher than the rate of interest on shorter duration loans.

Also, interest rate on loans for used cars is higher than the rate of interest for new cars – it is higher by 2 – 4%.

The interest rate for auto loans is a fixed interest rate – the rate remains constant for the entire tenure of the loan, and does not change with a change in the prevailing interest rates.

The current rates of interest for car loans (for new cars) range from 14% to 16%.

Needless to say, the lower the rate of interest, the better it is.

Prepayment Penalty

There is a heavy prepayment penalty in case you want to pay back your car loan ahead of schedule – it ranges from 4% to 6% of the outstanding loan amount.

There can also be a limit to the amount you can prepay – for example, the bank may stipulate that you would incur a fee if you prepay more than 10% of your outstanding loan amount.

Some banks do offer zero prepayment penalty – especially during special promotions. Try to choose such a bank if possible. Otherwise, opt for a loan that has the lowest prepayment panelty.

Processing / Administrative Charges

This is a fee to cover the administrative expenses that the bank incurs to process your loan application. It can be anywhere from 0% to 2.5% of the loan amount.

This fee has an effect of decreasing your loan amount (and therefore, increasing the cost of your loan). For example, if you avail a loan of Rs. 3,00,000 with a processing fee of 2%, you would end up getting only Rs. 2,94,000.

Documentation Charges

Many banks charge documentation charge to cover their expense of documentation of your loan – for example, the amount they spend on stamp papers. This is usually a small amount (Rs. 200 to Rs. 1000), but should anyway be considered while comparing loans from various banks.

Advantages to Self Employed / Businesses

If you are self employed and buy a car on loan, you can claim the interest paid on this loan as an expense which can be deducted from your earnings. Similarly, you can claim depreciation on the car as an expense.

 

Variants of Margin Money Scheme

Advance Equated Monthly Installment (Advance EMI) Scheme

Here, you get loan for 100% of the cost of the car. But the caveat is that you have to pay 4 to 8 EMIs in advance.

What does this mean? This means that you get a loan that is less than 100% of the cost of the car, but still pay a higher EMI (and higher interest) because the EMI is calculated on 100% of the amount!

Verdict: This is just a marketing gimmick, so avoid!

Security Deposit Scheme

In this scheme, you pay 10 to 30% of the loan amount to the bank as a security deposit for the loan, and the bank finances 100% of the car value. You earn an interest on this deposit, but this interest is lower than the interest on your loan. The deposit, along with the interest, is returned to you once you repay the entire loan.

Again, you get a loan that is only 70 – 90% of the cost of the car, but still pay a higher EMI (and higher interest) because the EMI is calculated on 100% of the amount!

Verdict: This is again only a marketing gimmick, so avoid!

 

Hire Purchase

Apart from the margin money scheme, this is another option of financing your auto purchase.

Here, the financial institution actually buys the car on your behalf, and you “hire” the car from the institution. Under the agreement, you “purchase” the car from the financial institution at the end of the term of the agreement. It should be noted that this amount is usually very low – it can be as low as Re. 1!

The Hire Purchase option for financing a car is usually offered by Non Banking Financial Companies (NBFCs).

Advantages to Self Employed / Businesses

If you are self employed and buy a car through Hire Purchase, you can claim the interest paid on this loan as an expense which can be deducted from your earnings. Similarly, you can claim depreciation on the car as an expense.

 

Lease

This is another option for financing the purchase of your car.

Here, the bank owns the car. The bank (called the Lessor) leases it to you (called the Lessee) for a fixed monthly amount. At the end of the lease, you have an option to buy the car at a predetermined price.

Leases are also usually offered by NBFCs.

Advantages to Self Employed / Businesses

If you are self employed and lease a car, you can claim the entire lease amount as an expense which can be deducted from your earnings. But since the car is owned by the bank, and not you, you can not claim depreciation on the car as an expense.

 

Auto / Car Loan Players

All the major banks and NBFCs offer auto / car loans. Some prominent auto finance providers are:

  • ICICI Bank
  • HDFC Bank
  • CitiBank
  • State Bank of India (SBI)
  • Axis Bank (Formerly, UTI Bank)

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