0% downpayment for a car. How much interest are you actually paying?
Quite recently, I've been seeing more and more 0% down payment for cars.
Just a couple of days back, BYD launched a scheme for private-hire drivers.
The Business Times
This isn't actually new.
Back in February 2013, buyers could obtain 100% financing with loan tenures stretching as long as 10 years. Amid escalating COE premium, MAS restricted borrowing to 50/60% and shortening loan tenure.
For people new to buying cars, these days you can take a maximum loan of 70% or 60%, depending on the open market value of the car, because MAS have later relaxed their regulation.
Now that 100% borrowing is back, you may wonder how is this allowed?
Well, i'll leave that out from this article.
What I'm more interested is how much does 100% financing actually cost you?
Because what looks like a small difference in the advertised interest rate can hide a surprisingly expensive borrowing decision.
I wanted to explore the differences if you are paying a 70% loan versus a 100% loan.
First, let's understand how a car loan works. Car loans in Singapore are commonly quoted using a flat interest rate.
When you pay your car loan, your interest will not come down. Compared to a home loan, which is a reducing-balance interest rate. As you pay, your interest goes down.
But what you may not know is whatever interest that is being advertised on a car dealer website or SGCarMart is not the "REAL" interest. Lets say its 2.18% p.a.
This 2.18% is different from a housing loan 2.18%.
A rule of thumb to convert the car loan interest is to multiply it by 2.
The actual effective interest rate is more like 2.18% x 2 = 4.36% p.a
But let's check how close this rule of thumb is to the real effective interest
How a car loan interest work. It is very simple!
Assuming you took a 70% car loan of $100,000 for 5 years at 2.18%
Total interest = 2.18% x 100,000 x 5 = $10,900
Total loan + interest = $100,000 + $10,900 = $110,900
Monthly Repayment = $110,900 / (5 years x 12 months) = $1,848.33
You should end up with the same number if you use a calculator with SGCarmart or dealer
Convert this to Effective Interest.
Present Value = $100,000 (Loan you took)
Payment = -$1,848.33 (Payment you have to make)
N = 60 (How long)
Future Value = $0
Rate = 4.148%
So the car loan you thought was 2.18% is actually 4.148% p.a
Our ×2 shortcut wasn't too far off.
Now let's look at 100% financing
What really got me curious was because of an advertisement I saw.
70% car loan, the interest is 2.18%
100% car loan, the interest is 2.88%
At first glance, it may just be a 0.7% difference, kind of small, but if you were to apply the formula or the rule of thumb, the entire interest suddenly looked like 5.6% p.a. A little steep.
If we go a step further are break down the loans as 2 separate decision.
Using the same example as above, $100,000 loan for 5 years
Decision 1 : Take up a 70% car loan : $100,000
Decision 2 : Take up a 30% loan to pay for the downpayment : $42,857
Decision 1 loan is 2.18%. the total interest you pay is $10,900.
Decision 2 loan is 2.88%. Because of this loan, your 70% became 2.88%.
So the interest u are paying is $42,857 x 2.88% x 5 years = $6,171.41
Additional interest you pay on your 70% loan = $100,000 x 0.7% x 5 years = $3,500
Total interest on Decision 2 = $6,171 + $3,500 = $9,671
We should attribute all this interest to the $42,875 loan you took for downpayment.
The total loan + interest = $42,857 + 9,671 = $52,528
Repayment because of this decision = $875.47
Hence, the effective interest you are paying is 8.298%
What may appear as a small 0.7% p.a is actually hiding a 8.298% p.a loan decision
A marketing gimmick can conveniently hide the math behind and make an expensive purchase looks affordable.
Unfortunately, many Singaporeans may fall for this trap because they are unaware.
I hope this article helps!
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