Buying a car is an investment. While some can afford to finance it wholly in cash, most people opt for a car loan.
Some car dealers tie-up with certain lenders to offer financing options. However, you can choose to register for a loan with a bank of your choice. Banks in Malaysia offer up to 90% financing, over a maximum tenure of 9 years. An upfront payment of the remaining 10% is expected to be made at the start. You can also choose to pay more than 10% and reduce your loan amount as a result.
How is Car Loan Interest Rate Calculated?
There are two main methods of calculation employed in Malaysia – fixed or flat rate, and variable rate. Of these, the fixed rate method is used more commonly. This means that banks set a fixed rate that is to be calculated against the principal amount to get the monthly, and total interest payable. This rate does not fluctuate during the tenure of the loan or its repayment period. As a result of this, the instalment amount payable also remains unchanged.
With the variable rate however, the interest payable fluctuates throughout the tenure. A Base Lending Rate (BLR) is set at the start of the tenure upon which variable rates of interest are added that do not remain constant. Thus, the percentage payable during each instalment varies.
Since a flat interest rate is most commonly employed, let’s look at an example of how interest is compounded using this method.
|Computation of Total Interest||[5/100] x RM60,000 x 8 years|
|Computation of Monthly Interest||RM24,000/96 months|
|Monthly Interest Payable||RM250|
|Computation of Total Monthly Instalment||[RM60,000 + RM24,000] / [8 years x 12]|
|Total Monthly Instalment||RM875|
How does the Duration of My Loan Affect the Interest Payable?
While applying you will notice that banks offer a lower rate of interest for options with a longer repayment tenure. However, given that the instalments are calculated on a fixed rate basis, the total interest paid at the end of the loan will be far more than that of a loan taken for a shorter duration. As a result of this, you might complete the tenure paying far more than the real value of your car. If the borrowed amount is taken up for a shorter duration, the interest might be higher. However, the total amount paid as interest will be much lesser, therefore, making the overall cost of the financing more affordable.
To understand this better, let’s use the components of the previous example, but lower the tenure to 5 years.
|Components||Loan for 8 Years||Loan for 5 Years|
|Total Cost of Loan||RM84,000||RM78,000|
As you can see, the rate on the line of credit for 5 years is 6% resulting in a higher monthly interest payable in comparison to that of the 8-year option. Despite this, the total interest is far lesser thereby reducing the total cost of the loan by a large margin. Hence, if your budget allows you to make a higher monthly instalment, then opting for a shorter duration will be more cost-effective in the long run. It is important to choose an option that is best suited to your individual financial capability. Banks usually charge a fee if an instalment is defaulted during repayment so ensure that the expected monthly payment is easily affordable.
Are Prepayments and Pre-Closure Encouraged?
Most banks in Malaysia allow their borrowers to settle an outstanding car loan ahead of the date of termination. Some banks even offer a rebate on early settlements. This is calculated on the remaining period of the total tenure. In this sense, pre-payments on instalments are also welcome. With an early settlement, however, the lender could lose the anticipated earnings in interest. Hence, it is important to read the terms and conditions of the offer to ensure that the chosen bank does not charge a fee against such payments made in advance.
What are the Factors that Could Affect the Borrowing Rate?
There are certain factors that play a crucial role in determining the chargeable rate. Although some are within the control of the borrower, others are dependent on market conditions and the bank’s policies. A few factors taken into consideration while setting the borrowing rate are as follows:
- Credit Score – A car loan is easy to acquire from most banks. However, a bad credit score can cause banks to increase the chargeable rate as a precaution. It is always recommended that you check your credit score before applying for a car loan, and work on improving your score if it does not meet the requirements of the bank.
- Debt-to-Income Ratio – This ratio encapsulates your monthly income versus the total amount payable every month towards the repayment of existing debt(s), if any. Banks will also look into your monthly income. This is done to ensure that you can comfortably afford the monthly instalment value.
- Car Type – While purchasing a car using such financing, the bank will consider the car as collateral. In such cases, it is important for the bank to ascertain the resale value of the car in the long run to ensure a worthwhile price. This is done by taking into consideration the model of the car, the type of car, its market popularity, and its age in the case of used cars. The higher the resale value, the lower the interest rate. This is because the bank will be able to make up for lost interest and investment should the loan remain unreturned at the end of the agreed tenure. Likewise, the lower the resale value, the higher the rate, as banks will find it difficult to make up for their loss despite selling the acquired vehicle.
- Loan Tenure – The chosen duration of repayment has a direct effect on the borrowing rate charged by the lender. A shorter tenure is usually accompanied by a higher rate of interest, while a longer tenure is offered at a lower cost.
- Down Payment – The minimum required down payment on a car loan in Malaysia is 10% of the total price. However, if you are able to offer a higher upfront payment towards the purchase of the car, the principal amount required will also significantly reduce. As a result, the amount on which an interest will be charged will also be much lower. A lower principal amount means that the bank will have to bear lesser risk, and will be willing to offer the loan at a much lower rate.
Things to Consider Before Choosing a Car Loan
Choosing a car financing scheme that is best suited to your needs and financial ability is important. Here are a few parameters to take into consideration while making your decision:
- Fixed or Floating Rate – Although most banks offer car loans at a fixed rate of interest, if you are more comfortable with a floating rate then choosing an option that allows the same can be beneficial.
- Tenure – The tenure of the loan is an important aspect as it decides the overall interest payable. As mentioned, the longer the tenure, the higher the total interest. This is despite lower rates. However, a longer tenure also allows for smaller monthly instalments.
- Budget – Analysing how much you will be capable of setting aside towards the payment of monthly instalments is key. This is will ensure that you do not default on any payments, and that you can meet every instalment with relative ease.
- Additional Fees and Charges – Banks will charge fees such as processing fees, stamp duties, insurance coverage or takaful, and so on. Understanding these fees and how they will be charged will help you identify the total cost of acquiring the loan.
- Credit Score – As you now know, your credit score plays an important role in fixing the interest rate on the loan. Ensuring that you have a credit score that meets the requirements of the bank will allow for a lower rate chargeable. If you have a rating that is below par, spending some time on improving that score before applying will aid the process.
- Pre-Payment and Pre-Closure Policies – These policies vary from bank to bank. While some may encourage such payments, others might charge a fee against it. If you do plan on making such payments during the tenure, read all offer related documents to understand if there will be a penalty charged, and how much.
- Repossession Policy – Repossession is the bank’s right to claim ownership of the vehicle should you default more than one consecutive instalment. However, in Malaysia, banks cannot exercise this right if you have paid off more than 75% of the agreed loan amount. It is beneficial to note your bank’s repossession policy to make sure you are not subject to this at any point during repayment.
The interest rate on a car loan plays a major role in defining the total cost of the loan. Hence, paying close attention to the various rates, how they are applied, and the areas they affect can help in identifying ways to acquire the required financing at the lowest possible cost.