Assume that you’re looking out for a car loan and some bank offers you the following options:
- Rs 200,000 for 36 months at 9% fixed plus a processing fee of Rs 150, or
- Rs 200,000 for 36 months at 12.75% reducing balance.
Which of these two loan offers would you choose?
If you chose either of the options, without asking further questions, you’re wrong. The first one looks cheaper prima facie and is psychologically very appealing. The second one doesn’t say whether the interest rate is fixed or floating through the tenure. Both of them don’t say whether the EMI’s are in advance or arrears. This is where your level of financial awareness comes into picture. A loan that looks and sounds cheap most certainly isn’t so. I am aware of a recent incident where an expensive car loan masquerading as a cheap loan was pushed to a relative of a friend.
You should ask questions. Lots of them. There are no dumb questions in personal finance. It’s your money after all. And, your very first question to the bank should be to ask them for a complete loan amortization schedule for any option they quote so that you can compare firsthand the total interest component that you would be paying.
Awareness Fridays is my initiative to spread awareness on topics relevant to personal finance — every Friday. I urge you to take some time off and absorb this information — it’s pretty useful. And, as always, do spread the word if you find this useful.
Is there something called a floating EMI? I thought all these loans had a fixed interest, say around 13% everymonth of the original amount, i.e. after 1 time down payment.. What is this floating EMI?
Need not always be fixed interest rates. There is also the concept of floating interest rates (more popular these days) where the interest rate changes depending on the macro economic situation. In floating interest rates, the interest rates can either go up or go down and hence they are called floating.
When a floating interest rate actually changes, you will find that the bank either changes your EMI or changes the loan tenure. Usually, it is the tenure that changes first since the bank and you would like to keep the EMI fixed.