Fixed or floating rate? Choose floating-rate car loan if you plan to prepay

With interest rates peaking, you could benefit from a decline in them

Car sales are surging, and so are car loans. According to Reserve Bank of India (RBI) data, vehicle loans grew 22.1 per cent year-on-year in December. Besides getting a good bargain on the car, select the loan carefully to optimise your total purchase cost.

 

Fixed or floating rate?

 

Private banks usually offer fixed-rate car loans while public-sector lenders usually offer floating rates.

 

Gaurav Aggarwal, senior director, Paisabazaar, says, “Fixed-rate car loans are suited for those who prefer a fixed repayment obligation and are content with the current rates.”

 

While fixed-rate loans offer peace of mind, they are usually costlier than floating-rate loans. Also, at the time of prepayment, the lender usually charges a prepayment fee in fixed-rate loan. RBI’s rules prohibit them from doing so in floating-rate loans.

 

Adhil Shetty, chief executive officer (CEO), Bankbazaar, says, “While many lenders waive the prepayment penalty in fixed-rate loans, not all do so. Also, there may be a minimum period, or a minimum number of EMIs, for which you have to wait before you can prepay.”

 

Aggarwal says borrowers who plan to prepay will be better off opting for a floating-rate loan.
 

Chart

 

At present, we are close to the peak of the current rate-hike cycle. After perhaps one more rate hike, interest rates are expected to remain stable for some time. They may decline thereafter. If you believe rates could fall during your loan tenure, opt for a floating-rate loan.

 

Dealers offer fewer choices

 

Most dealers today have tie-ups with a few banks and financiers, so taking a loan at the dealership is convenient. Sometimes, you can get a good offer from a particular bank even at a dealership. Typically, however, car dealers have tie-ups with only a few lenders. This limits the choices you get and the opportunity to negotiate a better deal. Moreover, dealers get a commission on such loans, which usually translates into a sub- optimal deal for the customer.

 

Do your research on the offerings by a large number of lenders. One option is to go for a pre-approved loan from the bank with which you have a salary account. Shetty says, “That bank could offer you additional benefits, which may result in a better deal.”

 

On the other hand, if you go to a new lender (with whom you have no banking relationship), the documentation and verification process will be longer. However, checking them out will also mean more choices.

 

Sometimes, lenders and car companies have loan tie-ups for specific models. Such arrangements can also result in a lower interest rate, zero processing fee, and so on.

 

You also stand a chance of getting a good deal from a loan distributor. V Swaminathan, executive chairman, Andromeda Loans and ApnaPaisa, says, “A loan distributor typically has tie-ups with a large number of lenders and can hence offer better options. Lenders, too, offer better rates and schemes to large distributors, which eventually get passed on to customers in the form of lower rates, lower processing fees, and so on.”

 

20/4/10 strategy

 

A longer tenure means a costlier loan. Car buyers should consider adhering to the 20/4/10 rule. Make a down payment of 20 per cent or more. Restrict the loan tenure to four years or less. And don’t let the EMI exceed 10 per cent of your monthly income. M. Barve, founder, MB Wealth Financial Solutions, says, “Adopting this strategy will reduce the total cost of purchase.”

 

Alternative loan options

 

If you don’t have a good credit score (750 or above), consider taking another loan. Barve says, “You could take a secured loan, like a gold loan, if the interest rate is attractive.”

 

Businessmen and self-employed persons should consider taking a loan in their company’s name. Dilshad Billimoria, board member, Association of Registered Investment Advisors (ARIA), says, “The company can claim depreciation. The employee may be provided the lease purchase option, allowing the lease amount to be deducted from his pre-tax salary.”