People tend to spend days trying to make sure they get the price they want on their vehicle of choice, yet most will not invest nearly enough time and effort into searching for the right auto loan. It is easy to go with the financing option your car dealership is offering you, but it may not be the best one. With the prices of cars continuously growing, a car loan is a necessity for most consumers. All major banks offer auto loan facilities as long as you are between 21 – 60 years of age, and can meet their minimum monthly income requirements which are usually around Rs. 30,000 and go up with the value of the car. Loans are best suited for new cars although used cars up to 5 years may also be financed.
At the end of the day, the most important factor to consider when applying for an auto loan is how much you can truly afford. It should not be used as a means to buy a car that is out of your budget. Auto loans are secured loans, meaning the car itself is the collateral against the loan – i.e. in the event of a default, the bank will seize the car.
Your Down Payment
On average, all banks in Pakistan require a minimum 20% down payment on the value of the car. Some banks offer as low as 15% but that is restricted to new cars and sometimes only certain models. It may also go up to 25% or 30% depending on the car. Let this be the starting point of defining your budget. For example, if you can afford a Rs. 100,000 down payment, the maximum value of the car you can afford is around Rs. 500,000. In addition to this, banks will typically charge an upfront processing fee along with fees for insurance, especially if you opt to include a tracking device in your vehicle. Please note that all banks require you to purchase auto insurance and most will offer a packaged deal which is usually the most economical option. Some banks such as Al Falah allow you to defer these upfront charges and include them as part of your monthly installment.
Your Monthly Installment
Auto loans can be taken up to a duration of 7 years so it is critical to ensure that you are able to afford the monthly instalments comfortably rather than being crippled by them in the long run. It is helpful to think about it in percentage terms. How much of your monthly income are you willing to set aside after necessities such as rent, utilities, food, etc.? It depends on your style of living and overall household income and expenses but going above 10-15% is not recommended. Some banks also offer Residual Value product. This means deferring a certain amount of your payment (up to 50% for example from Bank Al-Falah) to the back end of your loan tenure as a lump sum (also called balloon payment). In this case, you would have only paid interest on 100 – 20 – 50 = 30% of the value of the vehicle (assuming a 20% down payment and a 50% balloon payment). However, the Residual Value offer is usually only limited to new cars and certain makes and models. It is also important to be confident in your ability to make that balloon payment at the end of your loan tenure.
Islamic auto finance (Ijarah) will be discussed at a later point. As far as conventional banking is concerned, there are 2 types of interest rates offered by banks for auto loans – fixed and variable. Fixed rate means that the annual interest rate on your loan is fixed, for example at 16 to 17% from UBL. A variable interest rate is linked with KIBOR (Karachi Inter-Bank Offer Rate – the rate at which banks lend to each other). KIBOR is issued daily by SBP and is currently hovering around 5 to 6%. Banks will set their lending rate by adding a fixed number to KIBOR, for example, MCB starts at KIBOR + 2.5%. This additional number will vary due to factors such as the value of the car, the duration of the loan, etc. It generally means your repayments will vary from month to month. Variable interest rates are more common in Pakistan and are generally lower than fixed rates – but that may change over the course of your loan as KIBOR changes. For example, in March 2015 KIBOR was around 8%. It takes a certain level of knowledge and sophistication to be able to predict how the money markets will behave; on the other hand, you may shield yourself from this volatility by opting for a fixed rate.
Duration of the Loan
Banks offer a minimum of 1 to a maximum of 7 years to repay your auto loan. We discussed the importance of keeping your monthly instalment manageable – but it is equally important to keep the total cost of the loan in mind and not be fooled by the reasonable monthly payment. Prolonging the duration of your loan may reduce your monthly instalment, but it will increase the overall cost of the loan. For example, a Rs. 50,000 monthly payment for 60 months would cost you Rs. 3,000,000. Alternatively, Rs. 40,000 payment over 84 months would cost Rs. 3,360,000 in total – an additional Rs. 360,000 in interest. If you cannot afford a monthly payment over 48 months, you should consider a less expensive vehicle. Long-term loans of 6 to 7 years can be very expensive especially as the value of the vehicle also depreciates. Banks will allow you to pay off your loan before its maturity, but as any other loan, you would incur further charges, so planning is key!
Keeping the above variables in mind, it is advised to follow a 20/4/10 rule. This means making a down payment of at least 20%, financing the car for 4 years and capping the monthly payment at 10% of your gross income. Find out which auto loans fulfill these criteria for you using our website with just a few clicks!
Islamic Auto Finance (Ijarah)
Your personal preferences may be towards Islamic banking. More and more banks are offering Shariah-compliant products – for example, Meezan Bank, Bank Islami and Dubai Islamic Bank. In general, the economics of both conventional and Islamic auto finance are quite similar. The main difference between the two is ownership. Under conventional auto loans, the customer purchases the vehicle and bank provides a loan against it, whereas under Ijarah (leasing), the bank purchases the vehicle and leases it to the customer, charging rent. Under Islamic financing, the vehicle is not transferred in the name of the customer, but he/she is only given usage rights. Therefore, any loss to the vehicle beyond the control and absence of negligence on the part of the customer is borne by the bank. There are other differences between conventional and Islamic auto finance which we shall discuss in the next article. From the consumer’s perspective, the cost of the transaction is very similar – it is simply a matter of personal preferences and beliefs. So regardless of which option you lean towards, the principles mentioned above still hold true.