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Tuesday, April 15, 2008

Floating Rate - Now, Also in Indian Car Loan Market

Recently, one of the major banks in India announced the introduction of floating rate car loan. Floating rate option till now was only available for the home loans of longer tenure. But, is it a viable option for the short tenure, 3 to 5 year loans to own a car?

To draw any conclusion, we have to look at the interest rate differential available between the floating rate and fixed rate loan for purchasing a car. The differential is 50 basis points (100 basis points make 1%). That is, if the borrower can get a fixed rate car loan from that Bank for 14%, the floating rate will be available to you at 13.5% rate of interest. Monthly outgoing for the fixed rate loan will remain the same for the entire loan tenure. Whether the interest rate move up to 16% or it moves down to 12%, the monthly outgoing remains unaffected.

On the other hand, speaking technically, in a floating rate option monthly outgoing will reduce if the interest rate moves down or increases if the interest rate moves up. In such a scenario, the answer to choose an interest type depends on the risk taking capacity and outlook on interest rate movement for the next few years.

1. If the borrower does not want to take any risk and wants to freeze the outgoing, he should go for a fixed rate car loan.

2. If you are willing to take risk, but you think interest rate is going to rise, again the best option is the fixed rate loan. This way you can avail a lower interest rate compared to the anticipated future higher interest rate.

3. If there is anticipation that interest rate will move down in the next few years, the ideal option would be to take a floating rate loan plan. This way interest rate on the loan amount also will move down. Theoretically, these may be ideal scenarios, but in real life, things work out a little differently. In real life you face underlying challenges.

Is there a guarantee or legally binding agreement that banks will reduce interest rate if the general interest rate starts moving down? Sadly, there is no such guarantee offered by the banks. The very concept is new in the car loan segment.

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Labels: Car Loan

posted by Khate @ 11:43 PM

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