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Solve the Car Loan Interest Rate Puzzle!
Getting a car loan is often the most cumbersome and complicated process in buying a car. The high interest rates and regular monthly payments can be extremely taxing on a person’s income if the person is not careful in choosing the right car loan scheme and rate of interest. There are two types of interest rates on car loans: Fixed and Floating. The decision to choose one or the other depends on your risk bearing capacity.
The key is to identify the major difference between the two types of interest rates. In a fixed interest rate scheme, your EMI remains the same throughout the tenure of re-payment. However, in a floating interest rate scenario, the rates of interest fluctuate based on the then-current RBI regulations. For example, when you avail a car loan, the interest is calculated in basis points. Assume that you settle for an interest rate of 16 percent when you apply for a car loan. Also assume that 100 basis points are equal to 1 percent. Then, if your basis points goes down by 75, your fixed interest rate will still stay the same at 16 percent, but if you have opted for a floating interest rate then your rate of interest will decrease along with the basis points and come down to 15.25 percent.
Be careful in choosing the right type of interest rate and conduct a small market research on the Internet before making a final decision. After all, interest rates have been increasing for the past five years and have not seen a downward trend. This means that a person who has taken a floating interest rate has had to pay a higher rate of interest every month compared to a person with a fixed interest rate. In case you do not like taking financial risks and know that interest rates are going to rise in the future, the best option will be to go for a fixed rate of interest. However, if you are extremely sure that the loan rates will go south and are willing to take the risk, then go for a floating rate loan, but be prepared to pay high EMIs if your calculation is turned upside down.
A floating rate of interest needs better understanding than a fixed interest rate. A floating interest rate consists of three parts:
- Effective rate is the actual rate of interest applicable to the car loan taken.
- Benchmark rate is a reference rate that is higher or lower than the actual rate.
- Mark up or Mark down rate is the difference in the above two rates.
Banks often change the effective rate by changing the Benchmark rate or Mark-up rate. If the benchmark rate of 12 percent goes down by 1 percent, then automatically the effective interest rate also goes down by 1 percent. Therefore, the benchmark rate of 11 percent in addition to the mark up rate of 4 percent equals an effective rate of 15 percent, which is lower than the original effective rate. However, banks have their own method of correction. Banks always opt to change only the mark up rate while maintaining the same benchmark rate. This ensures that you always have a fixed mark up rate for the loan tenure.
In the long run you may end up paying more than what you had planned for. Moreover the pre-payment facility is higher in floating rate loans than in fixed. The best course of action is to study your own case separately from others and gather enough data using car loan tips that will help you make an educated and relevant decision.
