Have you ever played board games with a kiasu friend? I have. Since he doesn’t want to lose, he’ll look for every possible loop hole to exploit in the game. Naturally, he wins most of the time. Now, I’m not saying his style of playing is right or wrong, just that it’ll be a while before I play games with him again.
There’s a similar situation when buying a car in Singapore. Yes, there are rules and restrictions to getting a car loan, but some dealers have found every possible loop hole in those rules and exploited them. We’re not saying whether it’s right or wrong, but that us Singaporeans need to go in with our eyes open about the financial consequences of using these loop holes.
Consequences? What consequences?
In 2013, MAS set out strict rules regarding car loans. You could only take out a loan of not more than 60 per cent of the cost of the car, and you could not take longer than 5 years to repay the loan. This made it very difficult for many people to afford a car. Not only would they have to cough up a significant downpayment, they would also end up repaying a hefty monthly amount.
Sure, you may be conned… I mean, convinced by used car dealers, parallel importers or other financial institutions that exploiting these loop holes will save you money compared to playing by the rules. Often, they’ll “forget” to mention that there might be long-term effects as well, consequences that won’t affect you immediately but down the road, when it’s too late to do anything about it. Let’s look at three methods that try to work around the rules set by MAS.
This is a practice commonly used by authorised car dealers, to help customers reduce the amount of downpayment they have to pay. Let’s use an illustration to explain:
Ms Lee wants to buy a car that costs $100,000. Because the car loan can only cover up to 60% of the price, it means that she’ll need to come up with a downpayment of at least $40,000.
However, say the dealer offers an overtrade of $10,000. This means that the purchase price is artificially inflated to $110,000. Subsequently, the 40% downpayment amount should be $44,000. However, because of the overtrade, the downpayment amount is actually less $10,000 or $34,000. The dealer has “saved” Ms Lee $6,000.
So what’s the catch? Because the purchase price was artificially inflated, it means that the car loan amount has also increased. Using the illustration above, it has increased from $60,000 to $66,000. Assuming an interest rate of 1.6%, this means that Ms Lee has to pay about $100 more each month over a 5 year tenure. This might be more than Ms Lee can afford.
Even if she can afford it, it will also affect her Total Debt Servicing Ratio or TDSR. Remember that TDSR rules means that Singaporeans won’t be able to borrow more than 60% of their monthly income. Even though it’s only an extra $100, this could restrict Ms Lee from getting a larger home loan, later on.
2. Invoice Inflation
This is a practice sometimes found with second-hand car dealers. What these dealers do is claim they can offer you an “in-house car loan” that covers a higher proportion of your purchase price. This is normally 70% to 80% of the purchase price, but some may even be advertising a 100% loan.
Now, here’s where it gets insidious. Invoice inflation means that the seller inflates the value of the car in order to obtain a higher loan amount from the bank. Say the car only costs $100,000. Officially you can only get a loan of $60,000 from the bank. However, if the seller inflates the value to say… $150,000, then the bank can give you a loan of $90,000. This is 90% of the original purchase price, which means you only need to pay a downpayment of 10%.
So what’s the catch? The value of the car may be artificially inflated to a point where the bank is unable to issue the loan, because your monthly income is not high enough. Trying to find that sweet spot between how much the bank is willing to loan and how much of a downpayment you can afford should be a pretty strong hint that you might not be able to afford that car on your salary.
3. Balloon scheme
This practice is offered by some financial institutions, especially for used cars. Even though they charge a higher interest rate for the “in house car loan”, you end up paying less each month. What they do is subtract the scrap value of your car from the loan amount before calculating the lower monthly repayment. This may seem like an extremely good idea, but let’s see exactly how it works:
Let’s take the illustration of a used car costing $50,000. Assuming you take out a car loan of 60% of the amount with an interest rate of 1.6% over 5 years.
The total you can expect to pay is $52,400, or $540 a month.
In the “balloon scheme”, the scrap value is deducted from the loan amount. The scrap value is determined by the PARF rebate and is determined by the age of the car at de-registration. Let’s assume the used car only qualifies for the minimum PARF rebate of 50% of the ARF paid or about $7,000.
Let’s assume the car loan is paid at an interest rate of 2.8% over 5 years.
The total you can now expect to pay is $54,200. However, after deducting the $7,000 scrap value of the car, that’s only $47,200 or only about $453 a month.
That’s a difference of $87, or about 16% less each month. This lower amount could make all the difference to your TDSR, especially when you’re trying to take out a home loan.
So what’s the catch? To enjoy the benefits of this scheme, you must have driven the car until it’s ready to be scrapped. That’s the only way you can be assured of having the money to pay off the minimum PARF rebate at the end of the loan. If, for some reason, you’re in need of money and need to get rid of the car earlier, you may not only face higher penalties for early repayment, you’ll still have to keep paying off the loan’s higher interest rate.
What other car loan loop holes have you heard of? We want to hear from you.