The drawback of a step-up scheme is that you may end up taking a higher EMI commitment based on future income, which is uncertain.
HDFC Bank recently introduced custom-fit features on its car loan offering. Titled '#AapkeHisaabSe', the scheme increases car affordability through step-up and bullet repayment options. This feature is especially attractive for young customers in their initial years of employment and expecting strong income growth over the next few years. The scheme is available on all categories of cars from standard to premium.
But does it benefit the customer? Read on to know.
What is the scheme all about?
We all know when we take a car loan, we need to repay the loan in instalments, commonly referred to as the equated monthly instalments (EMI) mode of repayment. Under a standard car loan scheme, the eligibility is calculated based on current income of the borrower who then continues to pay an EMI for the entire tenure of the loan. Through its scheme, HDFC Bank gives customers two options for repayment -- Step-up repayment and bullet (balloon) repayment.
In the step-up EMI scheme, the EMI increases with time, unlike the standard EMI scheme where it remains constant through the tenure of the loan. For instance, the customer may choose to increase the EMI by 11 percent every year through the tenure.
In the balloon repayment scheme, a certain percentage of the loan can be repaid as EMI (calculated based on eligibility) while the balance can be paid at the end of the loan tenure. So unlike the step-up repayment scheme where the EMI gradually increases, a customer can pay an equal EMI for a certain chosen amount and the balance as a bulk amount in the last instalment. For example, a customer may decide to repay 70 percent of the car loan as equal EMIs over the loan tenure and the remaining 30 percent as a bullet repayment at the end of the tenure.
In both the repayment options, the eligibility is calculated based on a combination of current income and expected growth in income.
The key additional features of this scheme are zero foreclosure charges, eligibility of a top-up loan after nine months, insurance benefits including total protection against permanent total disability, accidental death and accidental hospitalisation and longer loan tenures of up to seven years (84 months). According to scheme, a car loan of up to Rs 3 crore can be availed on a wide range of cars and multi-utility vehicles under the step-up scheme and up to Rs 50 lakh under the balloon scheme. The interest rates charged are between 9-10 percent and offers 100 percent funding while buying the car.What works?
Under the step-up scheme, EMI can be up to 24 percent lower in the first three years before it gradually starts increasing. Balloon repayment allows up to 30 percent lower EMIs throughout the tenure and a larger lump sum amount at the end of the term.
Step-up scheme allows borrowers to buy the car of their choice without being constrained by their existing eligibility for the required loan amount. Whereas, the balloon repayment scheme is suitable for borrowers who want to keep their monthly expenses low and are certain of their ability to have sufficient savings to repay the last instalment of the loan.What doesn’t work?
The drawback of the step-up scheme is that you may end up taking a higher EMI commitment based on future income that remains uncertain. In case the career or income graph doesn’t progress as expected it may lead to undue financial stress at a later stage. According to Rachit Chawla, Founder and CEO of lending and investment advisory platform Finway, “You may also land into a bad credit score in case of failure in repayment in this scheme.”
Gaurav Gupta, Co-founder and CEO of online aggregator of financial products and services MyLoanCare.in said, “The caveat in balloon repayment scheme is that these loans turn out to be costlier as you keep paying interest on a significant loan amount outstanding till the end of the tenure.”
Let’s look at the repayment schedule for a borrower under the three schemes i.e. standard, step-up and balloon repayment. Let's assume a customer buys a car with a loan of Rs 10 lakh at an interest rate of 9 percent for a tenure of seven years.
A back of the envelope calculation shows under the standard repayment scheme the interest outgo will be Rs 3.51 lakh over the loan tenure at EMI of Rs 16,089 for seven years. But, in the case of step-up repayment scheme assuming lower EMI of Rs 10,000 in the first 2 years and a 21 percent increase after 2 years to Rs 19,399, the customer ends up paying 15 percent higher interest than that in the standard car loan scheme over the loan tenure.
Similarly, in the case of a balloon repayment scheme that starts with 27 percent lower EMI (i.e. Rs 12,653) compare to the standard scheme, the customer will end up paying 32 percent higher interest than that in the standard car loan scheme over the loan tenure.
“Young borrowers keen to buy a car using the step-up or balloon repayment schemes need to evaluate their loan eligibility, expected future income as well as understand the terms and conditions thoroughly of the loan scheme and compare them with standard car loan scheme before taking a decision,” said Gupta.
“This car loan feature is not a new feature from the bank. There are several banks giving the option to step up the EMIs on outstanding loan but they don’t advertise. It’s recommended as your income increases, make part payments towards the car loan and bring down your long-term interest costs,” said Adhil Shetty, CEO of an online aggregator of financial products BankBazaar.com.
It’s important to note. Balloon repayment scheme is risky because cars are depreciating assets and they lose value over time. So, by the end of loan tenure, the customer is left with a car that’s worth significantly less than what was paid for it and has to pay off most of what was borrowed at end of the tenure (last installment to the bank as explained in the table above).
It is advisable to avoid such step-up or balloon repayment options and remember the total interest outgo in these schemes works out to be higher than the standard schemes (refer to the table above) as the rate of repayment of the principal loan amount is slower vis-à-vis that of a standard car loan.
Even in the case where an owner wants to sell the car during the loan tenure, he/she may have to pay some amount to the new buyer to cover the pending loan. For instance, under the balloon repayment scheme, the owner will almost certainly owe the bank more than the depreciated value of the car at the time of selling since the last leg of the loan forms the biggest chunk.Follow @thanawala_hiralYou can now invest in mutual funds with moneycontrol. Download moneycontrol transact app. A dedicated app to explore, research and buy mutual funds.