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?
$24,750!
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!)