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It is worth taking a used-car loan?

Smita Tripathi

Is it worth taking a loan and buying a second-hand car? It is the new option that banks are offering - but it is costly and would-be buyers should study all the terms with extreme care.

The first problem is that second-hand car loans are much more expensive than loans on a new vehicle. For instance, ICICI charges interest at the rate of 18.5 per cent on a monthly reducing balance, for a loan of more than Rs 100,000 on a second-hand car. That's compared to interest of 14.5 per cent for a brand new set of wheels.

Similarly, ABN Amro Bank offers loans for used vehicles at 19.5 per cent (monthly reducing). The bank charges 14.5 per cent for a new car .

Let's take the hypothetical example of a person who buys a second-hand 2000 model Maruti Zen LX for Rs 270,000 and takes a loan of Rs 200,000 from ICICI for three years.

This buyer will end up paying an equated monthly instalment of Rs 7,280. On the other hand, a person who buys a new Maruti Zen LX for Rs 344,000 and takes a loan of Rs 300,000 for the same period would pay Rs 10,332 as EMI. A Rs 200,000 loan for three years has an EMI of Rs 6,450.

Secondly, while most banks offer up to 90 per cent of the price of a new car, a loan for a second-hand car covers only between 80 per cent and 85 per cent of the assessed value of an old car. In fact, banks such as ABN Amro give loans of only 70 per cent of the value of the car.

There's an additional catch. The bank will also make its own assessment about the value of the car. A bank official will value the vehicle and the loan will depend on what he reckons it is worth. Therefore, the loan sanctioned is on the basis of this price and not the price that the seller demands.

Thirdly, the tenure for which the loan is provided is also shorter than that for a new car. For instance, Citibank provides a loan of up to five years at the most.

The tenure of the loan depends upon the model and condition of the car. Thus, if you wish to purchase a 1998 model, you will have to repay the loan in two years, while a loan for a 2001 model can be repaid in five years.

Similarly, ICICI Bank gives a loan for a maximum of five years, provided the used car is not more than eight years old at the time of the maturity of the loan.

HSBC, on the other hand, gives a loan for a maximum of four years, provided the car is not more than seven years old at the time of maturity of the loan. State Bank of India and Punjab National Bank do not sanction loans for cars that are more than three years old.

Then, there's a processing fee that is charged. While applying for a loan, you have to pay a certain charge on the amount applied for.

The charge is calculated on the amount of loan applied for and not on the amount actually sanctioned. For example, if the processing fee is 2 per cent of the loan applied for, and you apply for Rs 10,000, you will have to pay Rs 200 as processing fee upfront.

And if the loan sanctioned is Rs 8,000, the money you actually receive is Rs 7,800 (8,000 minus 200 processing fee), but you have to pay the interest on Rs 8,000. This can make a big difference in the real cost of the loan.

The pre-payment penalty should also be considered while taking a loan. If a person decides to repay the loan before the end of the tenure he will have to pay a certain percentage of the outstanding amount as penalty. In the case of most banks it is 2 per cent.

The best move is to find a lender who doesn't charge a prepayment penalty (SBI, for instance, does not charge any prepayment penalty).

This way you can pay off the loan if you have the funds. Also, if interest rates fall, you can replace the higher cost loan with a lower cost one.

However, don't forget that most banks offer the option of pre-payment, but they don't give you the flexibility of part payment. Thus, if you decide to repay the loan earlier than the pre-determined period, you have to pay the whole outstanding principal.

ABN Amro and Citibank are exceptions to this rule. ABN Amro offers the flexibility of pre-paying up to 25 per cent of the principal amount of your car loan once every 12 months, at no cost.

More than this amount can be pre-paid at a charge of 4 per cent of the amount exceeding the initial 25 per cent.

To conclude, take a look at the interest rate, the tenure of the loan, the pre-payment penalty and processing charge before going for a second-hand car loan.

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