The Complete Guide to Car Loans

For a long time, my passion in the professional sphere has been marketing. After specializing in the field while pursuing my MBA, I started out in the marketing team of a retail electronics chain called Croma. At that time, I wanted to maintain a safe, sanitary distance from anything related to the F-word of Finance. When I started hunting for my next job, out of nowhere I found myself saying yes to a role marketing for, you guessed it, Auto Loans. I was a complete novice pushed over to the deep end, getting to see the back end credit processing and coming to terms with the nuts and bolts of Car Loans. As I was going through my blog, I realized that while being a basic product, it is still barely understood and there may be a time in
the lives of a lot of us when we end up needing one. So, here you go with a Complete Guide to Car Loans. To keep it simple, the guide is structured around the few points that one must understand about Car Loans. In case, you have no idea about Loans as a category, then start here to first get a lowdown on it.

Types of Car Loans

There are three types of car loans commonly seen today – New Car Loan, Used Car Loan and Loan Against Cars. In this post, I will focus only on the first two, letting go of the last one.

Loan to Value

Call me a motor novice, but before I joined that team, I wasn’t even sure of the difference between Ex-showroom (price of the car while in the showroom) and On-road price of a car (the price including all the things that are required to get the car on the road, including insurance, registration, taxes and any accessories you may choose).

While banks initially used to approve loans up to 90% of ex-
showroom price, in some cases, banks now lend the full 100% on-road amount for a car purchase. So, unlike Home Loans, today you can buy a car with no down payment at all. Of course, it depends on a lot of things like the car being bought, your credit score as well as other credit processing details.

As for borrowing in the case of a Used Car, most banks lend to about 80-85% of the valuation of the car. Most lenders have their own valuation teams that they trust. They will do a valuation of the selected car and accordingly offer a possible loan amount, again dependent on your income details as well as the credit score.

Tenure

Tenure is an important aspect when you consider your loan. Today, there are banks which go up to 8 years of tenure for a new car whereas, for a used car, the maximum tenure is uniformly 5 years. The minimum tenure in all cases remains 1 year.

In some ways, it’s a dual-edged sword. Longer tenure means a swankier car but it also means a longer overhang of the debt and a higher interest component. Ideally, you should keep your tenure as low as practically possible, while keeping your EMIs affordable.

Rate of Interest

The rate of interest in car loans does not vary as widely as it does for Home Loans or Personal Loans. In my books, it also does not make that much of a difference as it does for a Home Loan considering you end up paying a Home Loan for a decade and more.

Car Loan interest rates always fall between Home Loan rates and Personal Loan rates. The reason is simple. In Home Loans, the underlying asset is an appreciating property and the value keeps increasing. In Personal Loan, there is no underlying asset making it a riskier proposition for the lender as the borrower can easily abscond with nothing tieing them down. Car Loans are squarely between these two types of loans with a depreciating asset to back the loan.

Types of EMIs

We all are pretty much aware of the plain vanilla EMIs where nothing changes over the tenure. However, today banks have pretty fancy options to help you buy swankier cars and lure you into a debt trap. Sorry, that was just the cynic in me talking. But, as a borrower be aware of the potential stranglehold of EMI options like Step Up where your EMI keeps going up every year as well as balloon EMI where you keep your payments low every month and offset with a high lump sum payment at the end. It might just be more prudent to buy a car as per the traditional, standard EMI that you can afford.

Top-Up Loan

As mentioned earlier, Car Loans are backed by a depreciating asset. A top-up loan is an option that you can avail as part of the gap between the paid-off amount and the current value of the asset. So, for instance, after two years of paying off your Car Loan, your car is worth Rs. 8 Lakh and you are yet to pay off Rs. 3 Lakh, that leaves a gap of Rs. 5 Lakh. You are eligible to top up your loan for a part of this gap.

As you can imagine, this option makes sense only if the amount needed is small. The good part is that the interest rate may be lower than a Personal Loan.

Foreclosure, prepayment and balance transfer

While most banks do give an option of a balance transfer, in my view it is not worth it for a Car Loan. The interest rates will be barely different and considering the tenure, it will not amount to that much over
the term of the loan. Considering the hassles and cost that balance transfer involves, my suggestion would be to look at your lender for the life of the car loan.

As for prepayment and foreclosure, unlike Home Loan where these processes are mandated to be zero charges, that is not the case here. Most banks will have an initial period where you cannot foreclose or prepay. Even later, 5% of the principal outstanding as a charge for prepayment and foreclosure is a common practice. Some lenders even have restrictions on the number of times prepayment can be made. Make sure you get all these terms and conditions very clear before signing on the dotted line and
driving away into the sunset.

Where can I avail of a Car Loan?

In my experience, there are three large avenues of getting a Car Loan – car dealership, bank branch and a DMA or a Direct Marketing Associate. If the dealership has the muscle power, they often have good tie-ups with banks and also end up being a more convenient means of getting the process done in one place itself. On the other hand, if you have a strong relationship with a bank, then going to a bank branch or through your relationship manager might enable you to get a better deal. While DMAs are a more common avenue for Home Loans, they do end up doing Car Loans as well.

Documentation, processing fee and other charges

Like any loan, there is the usual documentation involved in the processing of the car loan, including the car documents for hypothecation (transferring in the name of the bank till the time the loan is paid off) as well as your income documents. Generally, documentation is easier when the loan is availed through the car dealership in case of a new car.

Different lenders have a different cost structure. In case you are applying through multiple lenders, ensure you check on these details before you take your call.

So there you have it. A (hopefully) simplified guide to Car Loans. If you still have any questions, just drop in a line in the comments below and I will be happy to respond.

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