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Planning To Take A Car Loan? Here’s All You Need To Know

Outlook Money

Planning To Take A Car Loan? Here’s All You Need To Know

Before taking a car loan, consider the 20/10/4 rule. It will make life a lot easier while managing your monthly budget. Here we look at this thumb rule and other tips to help reduce the financial burden.

If you plan to get a car loan, keep in mind the 20/10/4 formula. Some banks give up to 100 per cent loan on the on-road price of a vehicle, so you don't need to make any down payment.

However, it is advisable to make a 20 per cent down payment on the car's on-road price while booking it to reduce the financial burden later. Moreover, lenders may consider the loan at higher risk if your down payment is small, making them charge a higher interest rate.

Your equated monthly instalments (EMIs) should not exceed 10 per cent of the monthly income. Keeping the EMI within 10 per cent ensures your monthly budget is not disturbed.

In addition, the loan tenure should be at most four years. A longer repayment period may lower your monthly payment, but you may have to pay a lot more than the principal amount.

Consider the case where your monthly income is Rs 1 lakh. The down payment for a car with an on-road price of Rs 8 lakh should be a minimum of Rs 1.6 lakh, and the EMI should be approximately Rs 10,000. This would require you to take out a loan of Rs 6.4 lakh for four years. According to the rule, if you obtain a car loan at 8 per cent, the EMI would be approximately Rs 15,624, which is Rs 5,624 more than the limit.

Other Car Loan Tips

Based on the monthly income and other debts, the individual can modify the 20/10/4 rule. It is recommended that the debt be paid off as soon as possible, but note that banks charge prepayment and foreclosure charges. Some banks levy no prepayment charge after a certain period. Therefore, it is vital to inquire how flexible the repayment terms are.

One can avail of the loan at a fixed interest rate or reducible balance rate. The managing director and principal officer of Ladder7 Wealth Planners, Suresh Sadagopan, recommends that borrowers adhere to the reducible balance rate.

“A Rs 10 lakh loan at 7 percent interest comes up to Rs 70,000 per year in interest, so if the principal has to be repaid in five years, say Rs 2 lakh each year, a total of Rs 2,70,000 has to be paid each year. In this case, you are paying Rs 70,000 in the second year without receiving a credit for the Rs two lakh principal you repaid in the first year,” Sadagopan said.

“It may appear that a fixed rate is much lower than a reducible balance rate. Nonetheless, this approach is deceptive, and the actual interest you pay must be calculated since you are paying interest on a principal that you already repaid,” he added.

If your credit score isn't good, work on improving it. It plays a big role in deciding your interest rate. Also, when your credit score does not qualify you for reasonable interest rates, consider taking out a loan against securities or any other secured loan that offers lower rates.

As you may have doubts during the loan tenure, choosing a lender with a good customer service support team is advisable.

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