Business Standard

Two rates for loan against same car?

One is a flat rate, the other is on a reducing balance. Negotiate the former as it is more
expensive

Priya Nair
June 30, 2014

Banks are at it again - marketing retail loans with a vengeance. If you get a call from a telemarketer
offering a personal loan against your vehicle at a rate of 8.85 per cent, don't fall for it. First check what is
the base rate of the bank. The lowest currently offered by major banks is 10 per cent. So, a loan rate
below that is technically not possible.

If you probe more, you will be told that this is a flat rate for the entire tenure. On a reducing balance
basis (which is how most banks calculate the equated monthly instalment), the rate works out to about
16 per cent. The website of the bank in question mentioned the rates on the same product in the range
of 14.5 to 17.5 per cent.

In this case, a 2009-model Hyundai i20 was eligible for a loan of about Rs 3.2 lakh. That is about 80 per
cent of the car's current value, which is roughly about Rs 4 lakh. At a flat rate of 8.85 per cent, the EMI
for a three-year loan was Rs 11,251, while for a four-year loan it was Rs 9,069. The bank would deduct
Rs 5,000 as processing fee and a 30 per cent stamp duty from the loan amount, bringing it to lower than
Rs 3 lakh.

When asked further, the telemarketing executive admitted that on a reducing balance, the interest rate
works out to about 16 per cent and the EMI would be Rs 3,516 for a three-year loan and Rs 2,834 for a
four-year loan.

Flat rate versus reducing balance

"Flat rate loans charge for the amount you borrowed for the entire tenure of the loan, though you are
paying off the principal as you go along. The interest rate they mention on a flat rate loan is misleading.
In a reducing balance loan, you pay interest for the outstanding loan amount. Even if the interest rate
seems high in this case, it would actually be less as compared to a much lower rate quoted for flat rate
loans," explains Mumbai-based financial advisor Suresh Sadagopan.

Even banks which have flat rate loans will also have the regular reducing balance loans and customers
should go only for reducing balance loans as the effective interest the banks charge is difficult for a
normal borrower to arrive at, Sadagopan adds.
No benefit in pre-paying
Another disadvantage of a flat rate loan is there is no benefit in pre-paying it. Even if you pre-pay, the
principal, on which the customer has to pay interest, will remain the same. "Technically, it is not a fraud,
since the customer is being informed that it is a flat rate. But it may be more expensive and customers
should stay away from it," Sadagopan advises.

Read loan document thoroughly

Most retail loans are offered on a reducing balance. Some banks do offer personal loans at a flat rate,
says V N Kulkarni, debt counsellor with Abhay, a Bank of India-promoted debt counselling centre. "Banks
are trying to push products which are profitable. But since delinquencies were high, now they are taking
the car as a security. That is why technically this is a personal loan," he says.

According to Reserve Bank of India guidelines, banks have to clarify what a flat rate is and how the
instalments are charged. But many a time, borrowers in their hurry to get the loan sanctioned don't
bother to read the loan document in detail.

Loan against car

Having said that, a loan against your car is not a bad option if you are in urgent need of funds. It can
work out to be cheaper than a personal loan, since it is a secured loan. Your vehicle is the security in this
case. But remember that you will get only up to 80 per cent of the value of the car.

The interest rate accounts for depreciation in asset value. What is in it for the lender to give you a loan
against a depreciating asset? According to Nagendra Palle, chief executive officer, Mahindra First Choice
Wheels Ltd, the lender earns interest income and the interest rate charged takes care of the
depreciation of the asset. The depreciation of the vehicle is a problem for the car owner, not the bank.
The advantage for the borrower is that he gets to use his vehicle, though he takes a loan against it.

"The only concern for the bank is that the valuation of the car should be genuine," he says.

Physical factors such as the condition of the engine, tyres, battery, electrical and mechanical parts are
the factors the lender will consider for arriving at the valuation. The older your vehicle, the lower will be
the value and consequently the loan amount available against it will be lower. Most banks get vehicles
valued (for loans) by independent third-party agencies to ensure an objective and unbiased valuation.
These are done by trained engineers after physical inspection of the vehicle.

A loan against the car is also called a top-up car loan. HDFC Bank and Kotak Mahindra Prime currently
offer this type of loan. In case of Kotak Mahindra Prime (KMP) it is available only to their existing
customers, who have a good repayment track record of 12 months. HDFC Bank offers the loan even to
non-customers.

You cannot get a loan against your car if it is very old. For instance, HDFC Bank gives the loan for vehicles
not more than seven years old for private ones and six years old in case of commercial vehicles. So, if
your car is very old you will not be eligible for the loan.

Loan amount
The loan amount is linked to the current value. The lender will do a valuation and give you up to 80 per
cent of your vehicle's current value or the latest Insured Declared Value (IDV). Condition of the engine,
tyres, battery, electrical and mechanical parts, etc, are factors the lender will consider for arriving at the
valuation.

If you are a customer of HDFC Bank, then your vehicle might not require further valuation. But if not,
you will have to do a valuation and verification of your vehicle. KMP offers up to 25 times of your
current car loan EMI.

Tenure of the loan

HDFC Bank offers the loan for a period of one to six years while KMP offers the loan for one to three
years. Just like an auto loan, that is the loan for buying the car, it will be difficult to sell your car till you
pay off the top-up loan too.