Abhinav Kaul, 32, recently visited a neighbourhood pre-owned car dealer. He wanted to buy his first car. Upon queries, the salesman promptly dismissed any possibility of getting the vehicle financed. This appeared rather strange to Abhinav. Financing of new cars is hugely popular with lenders. But why is it not the case for used cars? Was it because the dealer did not want to go through the hassle? Was it because they want to get rid of the inventory as quickly as possible?
The used car loan market in India
Abhinav’s worries are not unfounded. The truth is, only 15% of used cars are financed in India. Compare this to new cars, where financing can be as high as 70%. Thankfully, the situation is changing for the better now. Lenders have begun addressing the huge market. Over three million used cars change hands every year. Used car loans (UCLs) can cover up to 90% of the car’s value. And interest rates are in the range of around 13–18%. The minimum loan amount pegged by most lenders is Rs. 1 lakh. The tenure for UCLs can be a maximum of five years for cars. But the car cannot be more than 10 years old. As he found more information online, Abhinav decided to opt for a UCL.
Should you prepay your UCL?
Repaying loans can be taxing for many of us. They tend to squeeze savings. And we worry about our EMIs. We tend to be insecure about what will happen if resources dry up suddenly. So, prepaying a loan is always a priority whenever you have the ready resources. Most people prepay loans when there is extra cash in hand. One can save on interest by foreclosing a loan. One also becomes eligible for new loans if there is a need. It is always wise to end the debt and gain peace of mind.
Cost of loan prepayment
If you choose to prepay a used car loan, be prepared to bear a cost for the same. Lenders charge foreclosure penalty. This amount depends on the principal outstanding, interest outstanding, and the tenure of repayment left. Lenders charge the foreclosure penalty to compensate for the loss of interest earnings. There are two ways to foreclose a used car loan:
1) Part prepayment: You can choose to pay off a part of the loan. Make larger payments than the EMI before the end of the loan tenure. This way, your principal outstanding and EMI will both reduce.
2) Full prepayment: This is tantamount to closing off your loan. You simply pay off your entire loan before the end of tenure.
Conclusion
Although it is advisable to clear debts whenever you can, you need to weigh the options. Before deciding on foreclosing a UCL, ask yourself what you will do with the money. Will you put the money to good use by investing somewhere? Will you use it to create an asset? If that is not the case, there is no point in foreclosing a loan. Remember that the penalty for prepayment varies from bank to bank. The prepayment penalty can be charged as a flat rate or it can be a percentage of the interest or principal outstanding. You must compare the penalty amount against the overall interest savings. If you see you are indeed making good savings, go ahead. Clear off the UCL.
