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A car loan is different from a home loan (updated in June 2018).

Tuesday, April 8, 2014

Gone are the days when someone could walk into a car showroom, put down a $1 deposit and borrow the rest.

How many car buyers actually give the topic of car loan some serious, in-depth thought before signing on that dotted line? 

Most don't think much more than "How much is the interest rate?" and "How long can I borrow for?"

Unlike a home loan which is amortising in nature which means that the interest payment for each subsequent instalment is based on a reducing loan amount, a car loan's interest payment for the entire duration of the loan is based on the initial loan amount. 

A car loan isn't amortising in nature.

So, if a person were to buy a $100,000 car and if he were to take a loan for $50,000 at an interest rate of 2.5% per annum for a period of 5 years, he would be paying $1,250 x 5 = $6,250 in interest or $104.16 per month. 

Total monthly repayment: $937.49.

Now, if a car loan were to be amortising in nature, just like a housing loan, the total interest paid over a 5 year period would only be $3,242.20. 

Total monthly repayment: $887.37. 

This is more than 5% lower than $937.49!

Imagine the good old days when someone could have walked into a car showroom, paid $1 and borrowed the rest for a $100,000 car to be paid over a duration of 10 years.  

How much would the interest payment be assuming a rate of 2.5% per annum? 


Monthly repayment: $1,031.25! 

How could this not be wealth destructive?

This is why, for years, I keep telling friends and family that if we want to buy a car and if we cannot afford to pay for the car without a loan, try to keep the loan quantum to a maximum of $20,000 and a repayment period of 3 years. 

Assuming the cost of debt is 2.5%, this would mean paying a total of $1,500 in interest payment which is what I personally find acceptable. 

Total monthly repayment over the next 3 years: $597.22.

So, if, for some reason, you are looking to buy a car now or sometime in the future, you might want to keep this in mind. 

Know how expensive a car loan actually is and try to limit its use to the absolute minimum.

Related posts:
1. Car dealers unhappy with LTA.
2. Lease cars, don't buy. (more calculations)
3. Cooling measures for cars.
4. Cooling measures for cars spurned.
5. A new car for $75,000? (depressing!)


JLee said...

i have always ask my friends whether their gain in time and convenience is greater than the $937/mth?

most give me intangible reasons like family have kids and they need to send kids to school. Some see it as a status symbol.

AK71 said...

Hi JLee,

Well, actually, the cost is much higher than $937.00 a month once we include the 50% upfront payment plus recurring costs such as insurance, road tax, maintenance, fuel, car parking and, maybe, car washes. -.-"

SnOOpy168 said...

Car is a status symbol for many mah. Was a babe magnet for the singles too. Easier to buy than a home (HDB), hand over IC & sign there.

Convenience perhaps is job dependent - like when i was an outdoor sales person. Need that set of wheels as company's transport allowance is really stingy. Convenience comes in after most of the public transport services stops running. But if you are out having a good time with a few drinks, you shouldn't be driving. Get a cab home lah.

Kids & wife are often poor excuse lah. Sure, there will be that emergency that requires instant transport availability to hospital. I believe there is this thingy call "taxi booking" or ambulance service. Wife is likely to demand it for face's sake - her friends hubby / family have it, so must she. Heard that the interest rate for car loan are really steep too.

Anyway.... i am wishing that the COE prices will drop and I want my motorcycle .... those long rides to Malaysia, I seriously missed.

AK71 said...

Hi SnOOpy168,

Like with anything else in life, if we can differentiate between needs and wants, then, it is easier to make prudent decisions. Of course, there is no guarantee that prudent decisions will be made. ;)

Then, we have to be aware of how someone's wants might actually be someone's needs. So, there are grey areas to bear in mind. :)

JT said...

Hi AK71,
Through your blog, I have learnt so much. Thank you so much and please know that I am a grateful beneficiary of your musings.
I have followed your advice to contribute to my SRS, SA and Medisave. If only I had read your post about car loans, I would have saved myself a lot of money. I have 2.5 years left on my 5-year car loan and would like to get your thoughts on whether I should bite the bullet and pay off my car loan before the 5-year period is up. Per your advice, my emergency fund and my warchests have been built up conscientiously in the past three years. My spare cash is sitting in the CIMB Starsaver and can be put to greater use, I think.
The Rule of 78 confounds me. How would AK71 rationalize this?
Maybank applies the following early settlement conditions:
In the event of early settlement, a charge of 20% of the total term charges payable under the HP Agreement, pro-rated for the unexpired hiring period (calculated in months).
In addition, a prepayment fee of 1% of the original loan amount will be levied.
The Hirer is also required to serve a 30-day notice in advance of the settlement date. Otherwise, interest in lieu of notice will be levied.

AK71 said...

Hi JT,

Unfortunately, car loans come with some rather unfair penalties. You really have to weigh the cost and benefit to see if it makes any sense to pay in full now.

Early redemption amount for car loans in Singapore is calculated using the Rule of 78. More interest is imposed on earlier payments compared to later payments. We start paying more of the principal borrowed much later.

Unfair? I think so. How can anyone think a car loan is a good thing (other than for the lenders) confounds me?

Other than the car loan, it seems that you are in good shape. :)

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