Why you should not fall for lower EMI offers

Exactly when the middle class is tightening their purse strings, banks are loosening them. Political and economic uncertainty is forcing the salaried to cut spending. They are not too keen on buying cars or homes, that too loans. What this means is that banks have little business coming their way. In order to find a way out of this low demand, they are coming out with various discount offers and schemes.

A report in_ The Times of India_yesterday said banks are providing 100 percent finance, waiving processing fees and lowering EMIs to lure car loan borrowers.State Bank of India offers auto loans with a lengthier tenure and a lower EMI of Rs 1,689 per lakh. Festival season loan offers from prominent banks have EMIs in the range of Rs 2,137 to 2,199 per lakh. Many banks have now stretched their loan tenure to seven years from the earlier 5 years. There are banks which don’t even charge processing fee to lure customers.

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So what should you do:

[caption id=“attachment_1022421” align=“alignright” width=“380”]  Image: moneycontrol[/caption]

The most important thing to look into when getting a loan is the interest rate and not the EMI. This is because banks can simply increase the tenure of the loan and decrease the EMI. Customers who are not financially savvy may assume that he or she is getting a good deal from the lower EMI offer. Remember, the longer the tenure the costlier the total cost of the loan.

Let us look at this with an example.Assuming you take a car loan for Rs 6 lakh at 11 percent per annum.

Case 1: If the tenure of the loan is 5 years, your EMI would be Rs 13,045, and the total cost of our loan Rs7,82,700.

Case 2: If the tenure of the loan is 7 years, your EMI would be Rs 10, 273 and the total cost Rs8,62,932.

You land up paying as much as Rs 80,323 more if you increase the term.

The above example clearly shows that though in the first case, the EMI amount is higher, the total cost of the loan is smaller. In short, longer the tenure, costlier the loan.

Now some banks like Punjab National Bank are offering 100 percent finance on ex-showroom price of vehicles. But is it smart financial choice? Not really, an age old personal finance rule says that when it comes to borrowing for car loans, you should follow the 20:4:10 rule, where 20 is the percent you pay upfront, 4 is the loan tenure and 10 is the percentage of your monthly salary that will go into loan servicing.

**Twenty Percent:**This figure makes sure that you have paid a good enough amount initially so that you don’t take a large amount as a loan. And the amount is will also be not so large that you cannot set aside.

Four years: Four years is a reasonable term to service a car loan. Of course, there are lenders who allow you to borrow for 7 years. As illustrated earlier, that works more in the lender’s favour. After all, the longer the loan tenor, the more you pay towards interest and hence your car becomes costlier. Of course, not to mention that the sooner you get rid of the loan, the sooner your name will appear on the car’s registration papers, in place of the lender’s.

**Ten percent:**This is ideal. But a lower proportion is better still. Anything more than 10% of your monthly salary could put you in a debt trap eventually.

So, the festival season is not yet over, at least for banks and consumer goods companies. They will be more than happy to lure you into buying things that need a loan. But before you fall for such offers, do read the fine print.