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Car finance - Make a smart deal
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Over the last five years, the dream of owning a car has been coming true more
and more easily for the country's burgeoning middle-class. Among the factors
most responsible for this rapid motorisation is the availability of relatively
attractive financing options.
The change again has been made possible by the new-found alliance between the
car-maker, the dealer and the financier. The fall in interest rates and the
juggling of margins between the trio has enabled the car buyer to bargain for
lower monthly repayments.
The recently announced alliances by Maruti Udyog Ltd (MUL), the country's
largest car manufacturer, with State Bank of India and its associate banks is
another attempt at taking vehicle financing to the masses. The tie-ups also gel
with the company's plans to increase its focus on the rural market, where the
demand for Maruti's entry-level car could increase with the availability of
cheaper financing
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Retail financing booms
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In the urban market, the steep rise in the number of passenger vehicles
purchased through retail financing is a clear indicator of the increasingly
easier availability and popular acceptance of this genre of car shopping.
From a share of about 45 per cent of all cars sold five to six years back, to
about 75 per cent now, car finance is the driving force behind the sales
numbers that most automobile companies boast of today. In fact, of the
remaining 25 per cent of car sales not funded through retail financing, a major
chunk would be institutional sales and only a small portion outright purchases
by individuals.
Further, the falling interest rate regime and the increasing competition in the
car finance segment have led to a substantial fall in the cost of funding a car
purchase.
From an effective cost (including processing fees, etc.) of about 24 per cent
on a monthly reducing balance basis six years ago, rates have crashed to about
8-11 per cent now depending on the car model. If the current falling interest
rate regime continues, the day may not be far when they match car financing
rates in the US, where it is 4-6.5 per cent, on reducing balance basis.
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Getting a good deal
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So, with the myriad car financing options available, how do potential car
buyers ensure that they get a good deal? What precautions are to be taken? What
are the new models? And what are the tips to remember that will make that loan
cheaper?
First, the obvious start to the car purchase process is the selection of the
car itself (which model and variant). The issue is dealt with in the
accompanying article.
After the car is selected, the next step is to calculate the amount of a car
loan that needs to be taken based on the buyer's current savings kitty and his
repayment potential. (See Table for EMI calculator and rates.)
Among the banks and companies that are major players in retail car financing
are ICICI Bank, HDFC Bank, State Bank of India, ABN Amro Bank, Kotak Mahindra
Primus, Standard Chartered Bank, Sundaram Finance and Ford Credit.
In addition to these financiers, car manufacturers also have preferred
financing arrangements with certain banks and non-banking finance companies
(NBFCs). For example, Maruti Finance has a preferred financing tie-up with nine
other outfits, including Countrywide and Citicorp.
Preferred financiers may offer more competitive interest rates than the others
for specific models of the manufacturer with whom they have tie-ups.
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Newer options galore
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Until now, the plain-vanilla traditional retail financing option has been the
only one available to buyers looking for a loan.
Here, the buyer either pays an amount as margin money upfront and part-finances
the car being purchased or, in some cases, takes a loan for the full amount
payable for the car.
The loan so taken is repaid over a fixed term at a pre-fixed interest rate,
with the total outstanding, including interest charge, payable in equated
monthly instalments (EMIs).
Among the newer financing models that have come up are:
Advance EMIs: Under this model, the buyer can take a loan for a longer duration
and in many cases at a lower interest rate. However, this would be applicable
and beneficial to customers who have the ability to pay a few EMIs in advance.
This would effectively reduce the tenure of the loan and at the same time
provide the benefit of a lower interest rate. This may be better than using the
excess cash to pay upfront margin money, as the tenure and size of the loan in
many cases determines the competitiveness of the interest rate offered.
Security deposit model: A variation on this could also be the security deposit
model, where the customer deposits his cash on hand in a fixed deposit with the
financier, instead of paying it to the dealer as margin money. The fixed
deposit will usually fetch a higher interest rate than a similar bank term
deposit.
But whether the deposit will offer a rate higher than the interest rate being
charged for the car loan will depend on the model and the buyer's bargaining
position.
Maruti's Versa (above) and Hyundai's Santro Xing... Options for the upwardly
mobile.
Balloon payment: A newer model that is yet to gain widespread acceptance is the
`End-of-term balloon' payment model. Under this model, the car buyer who is
taking the loan gets to pay a lower EMI.
This is either because the notional resale value of the car at the end of the
loan term is not factored into the total loan amount or because a pre-fixed
amount determined at the time of entering the loan agreement is expected to be
paid at the end of term.
In both the cases, the financier will reserve the right to retain the car if
the contracted amount is not paid to complete the dues under the loan.
As a result, in this model, the car buyer has to pay the balance `balloon'
amount (in most cases the expected market/ resale value of the car) at the end
of the loan tenure to get the vehicle transferred in his name. In comparison to
traditional retail financing, the total interest paid out under the `balloon'
payment model will invariably be higher.
However, the `balloon' payment being due towards the end of the loan tenure
allows for a smaller monthly instalment and so, is more pocket friendly
especially for car buyers who are hoping to upgrade to a higher segment.
For example, if the car costs Rs 4.5 lakh and the resale value at the end of a
five-year tenure is expected to be Rs 2 lakh, the buyer can take a loan for Rs
2.5 lakh under the `balloon payment' scheme and opt to pay the balance
(notional resale value) as a lumpsum at the end of the loan term.
The balloon payment model has not caught on among most banks and NBFCs because
of the inherent unpredictability of the used car market. However, with the used
car market becoming more organised and with the entry of manufacturers
themselves into this segment, there is a likelihood of the balloon payment
becoming more popular.
Lease and refinancing: A variation of the balloon payment model, which may also
be introduced in the country after a further maturing of the car finance
segment, is the retail lease financing of the car.
Under the terms of the retail lease model, the car buyer has to pay the
financier an EMI that consists of a monthly lease rent, finance charges and
other charges, if any.
At the end of the term, the car buyer has the option of paying the resale value
and transferring ownership of the vehicle, or selling the vehicle and paying
the financier's pre-assessed value of the car, or just paying a fixed charge
for the financier to dispose of the vehicle.
Refinancing has not gathered pace in the car finance market. Given the short
tenures and steep default charges, it is unlikely to be introduced in the near
future. However, under the balloon payment scheme and the lease option, finance
companies and banks are more likely to come up with a refinancing option for
the large end-of-term payment.
SuperSavings tie-up: The other new financing model that is being tried by a few
multinational banks and private sector banks is to tie a current account or a
super-savings account to the loan account.
Such tying up enables the car buyer to route any excess funds from the SB or
current account to the loan account, thereby reducing the outstandings with the
financier.
Financing options abound. But apart from the basic financing models on offer,
car buyers need to check out quite a few finer aspects of financing.
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Check these out too
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Apart from these financing options, the other points that need to be kept in
mind by the potential car buyer are:
A three-year loan term may be too short if the buyer's repayment capacity is
not high.
A seven-year term may be too long in the current falling interest rate
scenario. In most cases, the five-year term loan will be ideal.
Look out for hidden charges that may not be highlighted by the financier
upfront, such as documentation charges, processing fees, etc.
Interest rates and the EMI payable are always negotiable. Some banks also
tailor the EMI according to the car buyer's repayment capacity.
Most financiers have monthly targets to be met. As a result, they will be more
willing to squeeze their margins and pass it on to the customer in the form of
lower interest rates and EMIs towards the end of the month.
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