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The ABC of auto finance

Larissa Fernand

If you think housing finance is confusing, wait till you get into the auto finance maze. Unlike a housing loan where the finance company pays off the builder or the seller and you have to repay the financier in equated monthly installments (EMIs), there are other options in the case of auto finance.

Your first step would be to decide which car you have set your sights on and how much will it cost you.
Then make up your mind as to whether or not you are willing to put up a fairly large amount upfront.
Once that is done, calculate how much you are willing to put aside every month as loan repayment.
By then you will be all set to zero in on a scheme.

UNDERSTANDING THE EMI
The EMI is term used for the money that you will have to pay every month to the auto financier. Since you will be paying one installment every month, the 12 installments at the end of the year are together referred to as equated annual installment (EAI).
Once you and the auto finance company decide on the loan amount and the repayment tenure, the EMI is fixed for this time-frame.
Though it is an unequal combination of principal repayment and interest cost, it remains constant all through. The EMI payments at the start of the loan are heavily tilted towards interest payments and principal repayments are towards the end of the loan tenure. Hence, you end up paying more since the principal gets repaid only at the end of the tenure.

INTEREST RATE CALCULATION
The rate of interest will be calculated either on a monthly reducing basis or on an annual reducing basis. Monthly reducing basis means that the principal amount you pay every month is deducted when calculating the interest rate for the following months. Annual reducing basis means that the total principal repaid by the end of the year is deducted when calculating the interest rate for the next year.

Calculations on loans are also done on a daily reducing balance. But this is mainly done on credit cards whereby whenever a payment is made, the principal is immediately deducted. So if the payment is made on January 15, the interest rate adjustment takes effect from the very next day. In the case of monthly reducing balance, it takes place the next month and in the case of annual reducing basis, the next year.

The most expensive loan will be one that is calculated on a flat rate of interest, though its interest will appear the least. Don't be fooled. For example, if you take a loan of Rs 85,000 to be repaid in two years, the financier may quote a flat rate of interest at 9 per cent. On an annual reducing basis, it would work out to 11.77 per cent and 16.41 per cent on a monthly reducing basis.

So when companies just give you a rate of interest, ask them the method of computation. The thumb rule: the more frequently computed the better.

LOANS
If you take a loan, you are the owner of the car since the financier has already purchased it on your behalf. You have to repay the loan in the form of equated monthly installments (EMI). Incidentally, a loan is identical to the down payment scheme (see below). While the latter is the term used by non-banking finance companies, or NBFCs, the banks refer to it as a 'loan'.

HIRE PURCHASE (HP) SCHEMES
Here, the customer pays an EMI, part of which goes towards repaying the principal and part towards hiring the car. Therefore, he buys the car bit by bit. Some accountants state that under a HP agreement, the customer becomes the owner of the car, while others say that he owns it only at the end of the repayment tenure.
This grey area should not pose a problem for the self-employed since all interest (as banks call it) or hire charges (as non-banking finance companies term it) paid can be written off as an expense and depreciation can be claimed too. What you have to come to grips with are the three schemes: margin money, advance installment and security deposit.

• Margin money or the down payment scheme requires the customer to hand over 20 per cent to 25 per cent of the amount as a down payment with the balance 75 per cent to 80 per cent being financed by the hire purchase company.

• Security deposit scheme requires the individual to place a refundable security deposit of 20 per cent to 25 per cent of the loan amount. The company claims to finance the entire amount. On this refundable security deposit, you get a rate of interest which is fixed by the company, usually around 14 per cent (generally a couple of percentage points less than the cost of borrowing) and compounded either half-yearly or annually, all at the company's discretion.

• Advance installment scheme, too, has the company financing 100 per cent of the amount but the customer has to pay around five or six installments in advance. Under this scheme, since the down payment amount is increased, the EMIs are reduced.

LEASE
This one is targeted at corporates. The lessor (financier) is the owner of the car. Since he is the owner, he claims depreciation on the car and takes rent from the customer. At the end of the period, which is three years, he will sell the car to the customer at a predetermined residual value. Though the entire lease payout can be written off as an expense, you, as an individual, do not get any depreciation on the car.

ZERO PER CENT FINANCE
These are often linked to certain models with repayment tenures up to a year or a maximum of 18 months. This takes place when the dealer or manufacturer offer discounts which can be passed on to customers.

100 PER CENT FINANCE
There are no schemes which offer 100 per cent finance. The advance installment schemes and the security deposit schemes may be advertised under this head, but the fact that you are parting with some money as a security deposit or have to pay a couple of EMIs upfront shows that there is no such thing as 100 per cent finance.

WHAT HP SCHEMES TRANSLATE TO IN FIGURES

Amount you wish to pay upfront: Minimum
Repayment tenure: Shortest
Since you are looking at paying the least upfront, whether in the form of a deposit or advance installments, check out these options. The least outgoing will be from the security deposit scheme and the down payment scheme. The security deposit scheme works out to be the cheapest. But this depends on the interest being offered on the security deposit scheme. If it is much lower than 14 per cent, the benefit will drop.

	Security deposit scheme	Advance installment scheme	Down payment scheme
Cost of car	Rs 1,00,000	Rs 1,00,000	Rs 1,00,000
Repayment tenure	2 years	2 years	2 years
You pay	Rs 15,000 (15% of cost)	Rs 18,896 (4 advance EMIs)	Rs 15,000 (15% of cost)
Financier pays	Rs 1,00,000	Rs 1,00,000	Rs 85,000 (85% of cost)
EMI	Rs 4,861	Rs 4,724	Rs 4,179
Annual rate of interest (flat)	8.33%	6.69%	9%
Annual rate of interest (annual reducing)	10.92%	8.79%	11.77%
Annual rate of interest (monthly reducing)	15.25%	12.35%	16.41%
Total EMI outgoing	4861 x 24 = Rs 1,16,664	4724 x 24 = Rs 1,13,376	4179 x 24 = Rs 1,00,296
Total outgoing	1,16,664 - 3,600 = Rs 1,13,064 *	Rs 1,13,376	1,00,296 + 15,000 = Rs 1,15,296

* Since Rs 15,000 is returned with an earning of, say, 12 per cent per annum, you pay Rs 1,16,664 - Rs 3,600 (interest earned) = Rs 1,13,064.

Amount you wish to pay upfront: Minimum
Repayment tenure: Longest
If you are looking at paying up the minimum amount upfront and looking at the longest repayment tenure, this is what it will amount to. So you pay the least upfront amount on the advance installment scheme.

	Security deposit scheme	Advance installment scheme	Down payment scheme
What the car costs	Rs 1,00,000	Rs 1,00,000	Rs 1,00,000
Repayment tenure	3 years	3 years	3 years
You pay	Rs 15,000 (15% of cost)	Rs 13,668 (4 advance EMIs)	Rs 15,000 (15% of cost)
Financier pays	Rs 1,00,000	Rs 1,00,000	Rs 85,000 (85% of cost)
EMI	Rs 3,500	Rs 3,417	Rs 3,027
Annual rate of interest (flat)	8.67%	7.67%	9.4%
Annual rate of interest (annual reducing)	12.51%	11.12%	13.53%
Annual rate of interest (monthly reducing)	15.69%	13.98%	16.92%
Total EMI outgoing	3500 x 36 = Rs 1,26,000	3417 x 36 = Rs 1,23,012	3027 x 36 = Rs 1,08,972
Total outgoing	1,26,000 – 5,400 =  Rs 1,20,600 *	Rs 1,23,012	1,08,972 + 15,000 = Rs 1,23,972

* Since Rs 15,000 is returned with an earning of, say, 12 per cent per annum, you pay Rs 1,26,000 - Rs 5,400 (interest earned) = Rs 1,20,600.

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