Taking a car loan? Checklist of factors to weigh before rushing to borrow

Dubai: When comparing car-buying incentives, it’s important to consider the financial factors and do the math so you can make the right decision for you.

With many banks competing for loan seekers, even stationing themselves in car dealerships to lure customers, car financing is quite prevalent in the UAE with surveys revealing that 60 to 70 per cent of car buyers looking to take out a loan.

Easy and tempting?

For many people getting an auto loan can be easy and tempting. Show steady employment and sufficient income to cover your loan payment, and you will be enjoying even a brand-new car in almost no time.

Moreover, if you finance your car on an extended period like 48 or 72 months, you monthly payment may be lower than any car lease out there.

So is that a good argument that you should buy a car instead of leasing? Not really. There are many risks and downsides that come along with taking an auto loan that must be considered — alongside with the benefits of driving a nicer car.

So what factors do consumers need to consider when signing up for car finance and how do they calculate how much they can borrow? Here are a three factors to consider before you take a car loan:

Factor #1: Term of the loan

Many banks have prepayment penalties and even may require you to pay part of the remaining interest amount if you settle your loan early.

That means if you lose your job shortly after taking the loan or you decide to relocate for whatever reason, you will need to be able to sell the car and pay off the loan along with the interest.

Because cars typically depreciate faster than long-term loans are paid off, you may end up in a situation where you cannot even break even. The takeaway being if you’re in a volatile job situation or you think you may not be able to stick around until the loan is paid off, do not rush to buy a car.

If you’re willing to take your chances, be realistic about the fact that you may not be making much if any money from selling the car eventually.

Needless to say, you must shop around for the best rates and terms, even if that requires you to change banks where your payroll is deposited. Walking into a loan with significant penalties because it is available and easy to obtain is understandably a poor strategy.

Factor #2: Maintenance and insurance costs

If you’re buying a new car, it would probably be under warranty for several years. But if you’re buying a used car or if you’re taking out a loan that runs longer than the warranty period, you must consider the maintenance, repair and insurance costs.

Your loan monthly payment may be low compared to a lease car, but to get a full picture of your costs, you must take all of those other expenses into account. In addition, consider your options in case of the car breaks down.

A car-lease company is likely to provide you with a replacement almost instantly. But if you own your car, you will need to pay extra for your insurance provider to cover this situation.

Factor #3: Commitment to continued due payments

The decision to lease or buy a car goes back to how committed you’re to your current job and location. Even if a car payment may be lower than leasing a car, getting out of a car loan can be costly.

So if you see yourself in a stable job with no plans to relocate for several, go ahead and shop around for a good loan that has minimal costs if you decide to settle it early.

If you’re new to your job or your living situation is evolving, it may be wiser to lease a car for a while and avoid many hassles until things stabilise. One exception to this rule is, of course, if you can pay cash for your new car — whether new or used.

So if you have some extra cash and you’re willing to buy an affordable car, this could be a good option where you’ll avoid the hefty interest amount added to the car price, and getting out of owning this car will be as easy as finding a buyer.

Bank or dealership: Where to get your car loan?

You’re ready to buy a car, but first you need to figure out the right way to finance it. You can get your car loan from a bank or credit union, or you could go through the dealer. Both have their benefits and considerations, and it’s best to be informed about financing options before you ask for the keys.

You can usually apply for a bank loan even if you don’t have a specific car picked out yet. A bank professional can help you understand the loan application and loan process, and what to expect when you go to the dealership.

Banks often advertise promotional rates for auto loans. Approval can be quick, especially if you have an exceptional or even a good credit history. The bank will generally lock in an interest rate for a certain period, such as 30 calendar days, while you shop.

Once you have your car picked out and a loan approval in hand, it makes sense to consider financing options available through your dealer. The dealer will have its own car loan application and will likely send your car loan application to multiple lenders.

Each lender will pull your credit report, just as your bank did. They’ll then send the dealer their offers.

If you get a great financing offer that way, you could see if the bank wants to improve its terms. You can also ask the dealer to reduce the price of the car. Sometimes dealerships will offer financing to buyers with lower credit scores.

The dealer might give you extra incentives for using their financing, like a zero per cent interest rate, typically for a shorter period, or discounts on optional features for your car. If you choose financing through your dealer, you won’t have control over which lender ultimately provides the loan.

How banks calculate how much you can borrow for a car loan

UAE banks have a minimum eligibility criteria for securing a car loan:

1. No more than 60 months

Loans for the financing of new or used cars have a tenure of up to a maximum of 60 months. However, the maximum tenure of a loan can be shorter for older used cars.

For example, some banks require that a used car is no older than 10 years upon completion of the loan. As a result, a 2010 model bought today could only secure finance for under two years.

2. 20 per cent down payment

Consumers can only finance 80 per cent of the new or used car’s value, which implies a 20 per cent down payment. The down payment is generally paid directly to the bank, which then in turn settles the full value of the used car with its owner.

However, a few banks in the UAE ask used car buyers to settle the 20 per cent down payment directly with the seller after which the bank will settle the remaining 80 per cent of the car's value. Dealers can also offset the 0 per cent down payment by discounting the invoiced price of the car via a promotion.

3. Loan of at least Dh25,000

Many banks will have a minimum loan value they are willing to finance, which is generally around Dh20,000.

Since banks finance 80 per cent of the car’s value, this means a minimum car value of Dh25,000 is required for the car to qualify for financing (that is 80 per cent of Dh25,000, which yields a Dh20,000 loan).

4. Monthly payments must be less than half your salary

This means that the resulting Equal Monthly Instalments (EMI) of your used car loan cannot be greater than half your salary minus existing liabilities, which includes credit cards. So if you make Dh10,000 a month, your resulting car loan monthly instalments cannot be greater than Dh5,000 a month.

If you already have any other loan and you are paying off say Dh1,000 a month, then your new loan monthly instalment cannot be more than Dh4,000 and so on. If you have credit cards, then generally 5 per cent of your credit card limit counts towards your existing liabilities.

Rebate vs. lower interest: Which car incentive is right for you?

When comparing car-buying incentives, it’s important to consider the financial factors and do the math so you can make the right decision for you.

The car manufacturer gives you a one-time rebate (cashback) usually deducted from your car’s purchase price. Rebate amounts vary, but they usually range from Dh1,000 to Dh3,000.

The dealer also offers an interest rate on a loan that is lower than the normal rates offered. Car manufacturers usually allow only one deal per purchase. Sometimes you get to choose which offer to take.

However, keep in mind when evaluating the low interest rate offer that only those with excellent credit qualify for the lowest published rates. Consider the specifics to see whether the lower interest rate or the cash rebate is the better option for you.

If your goal is to end up with the lowest monthly payment, the cash rebate is typically the better alternative. However, variables such as how much money you put down, the total purchase price of the vehicle, any trade-in values and the length of the loan can affect the total you pay.

A longer loan term can lower your monthly payment, but you pay more total interest over the life of the loan.

Bottom line?

For each of your financing options, make sure you understand all the terms and conditions, and confirm that the costs fit within your monthly budget and for the long term.

Determine the total amount you will pay for the car over the life of each loan, as well as the potential trade-offs. You may not mind paying more overall by having a longer-term loan in exchange for lower monthly payments.

To help you calculate how much you can borrow, start off with half of your monthly salary and subtract any existing monthly instalments that you already pay. Then subtract 5 per cent of all your credit card limits. This will tell you the maximum monthly car loan instalment you are eligible for.

Then multiply this by 60 months, with the resulting figure the approximate car value you can go for. Reduce that number by 3 to 4 per cent to account for the interest your lender bank will charge you. Now that you know the numbers, you can actually start shopping for a car.

You can borrow from any financial institution in the UAE, not just the bank your monthly salary is remitted to. This gives you the freedom to shop around for the best interest rates.

Most car showrooms and dealerships have a few bank representatives on hand for customers to compare interest rates on the spot. Comparison websites also let you compare options online.

On the other hand, maybe you’re all about the bottom line, in which case a rebate or lower interest rate might be the deciding factor.

Once you’ve weighed the possibilities, you’ll be ready to make a well-informed choice. You can finalise your new or used car purchase, confident you’ve gotten the right deal for you.