SHYAM PATTABIRAMAN

The new-age family needs to organise its expenses and build assets. Here is help in making financial decisions.

Gone are the days when getting a bank loan was entirely at the mercy of the loan officer whose benevolence had to shine on you for a paltry sum with stringent repayment terms. Nowadays you have ‘pre-approved loan’ and ‘loan on phone’ — it is as if the banks are pleading with you to take a loan. (Who wouldn’t want that?)

Despite the prevailing high interest rates, I would term the credit environment as a buyers’ market. Just make sure you negotiate with your bank executive. Yes! Negotiate! You will be amazed at how easily the loan terms, including the interest rate can be relaxed, even if you have a moderate profile. In case you are serviced by an agent, and feel that you are not getting any leeway, ask to speak to his manager. Also, get at least three comparative quotes from competing banks and throw in some NBFCs (non banking finance companies) in your shopping list. Every rupee saved in margin down payment and interest counts. There are enough options available for an average Indian to avail of a loan on prudent terms as long as he knows what to ask for and evaluate what is being sold!

The most crucial element of a loan is the rate of interest. But something as straightforward and critical as the interest rate actually has three values: first — the flat rate, second — the IRR quoted by the bank and third — the actual IRR.

Let’s take these one at a time. Assuming you take a car loan of Rs. 1 lakh for tenure of three years and EMI of Rs. 3,331 (this is an actual offer in the market), the amount you would repay at the end of the three-year tenure would be Rs. 1,19,916. The additional amount you would have repaid over and above the principal is Rs. 19,916. On a per year basis, the same works out to Rs. 6,638 (19,916 divided by 3 years), or in percentage terms 6.6 per cent per annum (Rs. 6,638 divided by Rs. 1,00,000). This is the flat rate charged by the bank.

The reason the rate is so attractive is because it assumes simple interest, which is not appropriate for our EMI based loan. The flat rate is applicable, if you are allowed to pay only the interest at the end of every year for three years (Rs. 6,638) and repay the principal after three years (Rs. 1,00,000).

**IRR (quoted by loan agent) **

In a typical consumer loan you repay your principal in piecemeal — on a monthly basis, in the form of an EMI (which includes principal repayment + interest charges). Your principal outstanding (POS) on the loan reduces every month and the monthly interest is calculated on this reducing balance. Given that you are settling a portion of your loan every month, the bank is actually earning a higher interest rate (compared with flat rate) on your reducing balance— called IRR (internal rate of return). Why is it called internal? Well, one, it is the internal rate earned by the bank on your loan every month and two, because the principal you repay every month in the form of an EMI can be lent to another potential customer — as a result compounding the bank’s total interest earnings.

**Do-it-yourself calculation**

You can calculate the IRR in Microsoft excel using the RATE function. Excel access path: Insert> Function> Function Category: Financial> Function name: RATE (tenure in months, EMI, - loan amount). For our sample one lakh loan, use the formula RATE (36, 3331, - 100000) and excel would give you the monthly IRR of 1.02%, which when multiplied by 12 would match the annual IRR quoted by the bank. i.e 12.2 per cent per annum. That is almost twice the flat rate!

Thumb rule for checking whether the rate quoted by your agent is flat rate or IRR

The maximum rate on Fixed Deposit (FD) offered by a bank today is 9.5%. In our sample one-lakh car loan, the flat rate was 6.6%. If this were the actual interest rate charged by a bank, the bank will go bankrupt! (pun intended). The minimum interest rate (IRR) charged by a bank or NBFC should be greater than the available FD rates. If you feel you are getting a cheaper loan, then you are probably getting conned by an agent quoting the flat rate!

The Real Interest Rate (IRR) on your loan

The sad part now is that the annual IRR quoted by our financial institutions to customers, is not the actual IRR! Although the monthly IRR (1.02%) is correct, while annualizing it, you need to compound for 12 months and not simply multiply by 12. Compounding would give the actual rate on your loan i.e 12.9 per cent per annum. And this is the actual annual interest rate that you are paying on your loan. If you don’t have the patience to calculate, IRR can safely be assumed as twice the flat rate. (For those not challenged by formulas, this can be calculated by the usual compound interest calculation method (1+1.02 per cent)^12 –1, where 1.02 per cent is the monthly IRR and 12 is the number of months in a year, since you want to calculate the rate per annum)

So, while shopping for a loan, make sure you ask for the IRR (internal rate of return) and do all your negotiation based on this number! Happy shopping for credit!

**A few tips**

**Timing:** The best time to get a vehicle is at the very end of the month, or the last day. There are big incentives to sell a certain number each month (both from the manufacturer and from the financiers) and some dealerships will give you excellent deals just to make a sale to fill their quota.

**Negotiate** the car’s sticker price first, financing comes later. Dealers will ask you what you can afford to pay on a monthly basis. This is a trick to get you to stretch on the model by quoting a minor increase in the monthly payment. Tell them that the price of the car is all that matters.

**Manufacturer incentive: **Manufacturers often give special discounts to their dealers to encourage them to move a slow-selling model or a model that is on the verge of being phased out. Do your homework (using Google of course), on the recent press releases from the manufacturer. Buying an older model may be more profitable than you could imagine.

**Dealer referred financier: **Dealers make a tremendous amount from the commission they receive on financing deals they negotiate, probably more than they make on the cars themselves. Unless you state your desired loan terms (low interest, low margin etc.), you will find yourself signing up for the financier who pays the highest commission to the dealer!

Drive home a car for under Rs. 4,000 a month? These days, financiers offer loan tenures as long as seven years that may artificially lower the EMI, but such a loan is not optimal. You’re likely to continually owe more on your car than it’s worth, because your car is depreciating faster than you are paying your loan off! This means you can’t even sell your vehicle midway without losing money. You are better off considering a cheaper car than a longer loan.

**Accessories: **The % profit margin on car accessories is at least 3-4 times that on the car (no wonder these are called ‘Car Jewels’). This is exactly the reason why many dealers have an in-house accessories shop. If you are smart enough to negotiate on the invoice price of the car, you should not miss the opportunity for a steeper discount on the accessories.