Question:

Hi, I’m Jenn, a 27-year old Assistant Manager working in a local IT firm based in Kuala Lumpur. As I write, I’m earning RM 5,000 a month and have saved myself around RM 50,000 after 5 years of working.

I intend to buy myself a new car this year. I’m considering a Japanese model car which is priced around RM 100,000. I’d talked to Angie, a close friend about my ‘car’ plans. She suggested that I should opt for a car loan where its tenure is not more than 5 years. She believes that I would save interest payments on my loan and it is financially wise for me to get out of debt as soon as possible.

My question is: ‘Should I opt for a 5-year car loan instead of a 9-year car loan?’

First, I’d found the interest rates of loans to purchase a foreign branded car is at 3.0%, on average. The rates published are nominal interest rates. Thus, they are not the effective interest rates which borrowers would incur for their car loans. In this article, I’ll share:

– How to Calculate the amount of Monthly Installments of a Car Loan?

– How to Calculate the Effective Interest Rates of a Car Loan?

– One Major Consideration before Taking a Car Loan

## How Monthly Installments of a Car Loan is Calculated?

From above, the Japanese model car costs RM 100,000. Let us assume, Jenn is applying for a car loan where its nominal interest rate is 3.00% per annum and is placing RM 10,000 or 10% down payment to purchase her car. Here, I would show you 2 sets of calculations based on her car loan amount of RM 90,000.

The first is for a 5-year car loan and the second is for a 9-year car loan.

5-Year Car Loan

The formula to calculate its monthly installment is as follows:

Monthly Installment

= (Car Loan + (Car Loan x Nominal Interest Rate x No. of Years)) / No. of Months

= (RM 90,000 + (RM 90,000 x 3% x 5)) / (5 years x 12 months)

= (RM 90,000 + RM 13,500) / 60 months

= RM 1,725.00.

9-Year Car Loan

The formula to calculate its monthly installment is as follows:

Monthly Installment

= (Car Loan + (Car Loan x Nominal Interest Rate x No. of Years)) / No. of Months

= (RM 90,000 + (RM 90,000 x 3% x 9)) / (9 years x 12 months)

= (RM 90,000 + RM 24,300) / 108 months

= RM 1,058.33.

 No. Loan Tenure 5 Years 9 Years 1 Monthly Installments RM 1,725.00 RM 1,058.33 2 Total Interest Costs RM 13,500.00 RM 24,300.00

From above, Jenn may opt for a 5-Year Car Loan if she intends to ‘save’ on total interest costs in absolute figures of her car loan. However, if she intends to free up her monthly cash flow, then, Jenn may opt for a 9-Year Car Loan.

For now, it is too premature to decide on your ideal loan tenure, be it 5 years or 9 years. Thus, let’s move onto:

## How to Calculate the Effective Interest Rates of a Car Loan?

Once again, this involves the usage of the Internal Rate of Return (IRR) formula.

I had wrote one of its many applications in an article on Cash Advance. It comes with a 3-step process to calculate the effective interest rate of an investment or a loan (cash advance) offered by local banks. Here, I will also be using the same 3-step process to calculate effective the effective interest rates of a car loan.

Two sets of calculations would be given as follows:

5-Year Car Loan

Step 1: Work out the Cash Flow for the Car Loan

 Month Cash Inflows Cash Outflows Net Cash Flows 0 RM 90,000 0 RM 90,000.00 1 – 60 0 (RM 1,725.00) (RM 1,725.00) Total Cash Flows (RM 13,500.00)

By using the IRR calculator, you’ll find the IRR is 0.47% per month for taking up the 5-year car loan.

Step 3: Translate it to IRR on a Yearly Basis.

This is simple. Just multiply the IRR of 0.47% a month with 12 months. Thus, its IRR on a per annum basis is 5.64%. This is the true cost if you decide to obtain a car loan from the bank, which is not exactly ‘3.00%’ stated by the bank.

9-Year Car Loan

Step 1: Work out the Cash Flow for the Car Loan

 Month Cash Inflows Cash Outflows Net Cash Flows 0 RM 90,000 0 RM 90,000.00 1 – 108 0 (RM 1,058.33) (RM 1,058.33) Total Cash Flows (RM 23,299.64)

By using the IRR calculator, you’ll find the IRR is 0.46% per month for taking up the 5-year car loan.

Step 3: Translate it to IRR on a Yearly Basis.

This is simple. Just multiply the IRR of 0.46% a month with 12 months. Thus, its IRR on a per annum basis is 5.50%. This is the true cost if you decide to obtain a 9-year car loan from the bank, which is almost similar with 5.64% calculated for a 5-year car loan.

 No. Loan Tenure 5 Years 9 Years 1 Effective Interest Rates per year 5.64% 5.50%

## The One Main Consideration before Deciding on Your Car Loan Tenure is …

Do you plan to buy yourself a property in the near future?

Let’s use Jenn as an example. From above, she earns RM 5,000 per month from her job as an Assistant Manager. Jenn’s decision on her car loan tenure, be it 5 or 9 years, has a huge impact to the amount of loan eligibility if she intends to buy a piece of property in the near future. For instance,

Let’s assume, banks are comfortable to limit their lendings to a borrower of up to 60% of their monthly income. Thus, the maximum debt-servicing ratio (DSR) is 60%. In Jenn’s case, banks would limit their lending to an amount where her maximum monthly installment is RM 3,000 (60% of RM 5,000).

The installment includes debt repayments on mortgages, car loans, outstanding credit card debts, personal loans, PTPTN … etc.

5-Year Car Loan

As such, in Jenn’s case, if she opts for a 5-year car loan, her monthly installment is RM 1,725.00. She would be left with a loan installment quota of RM 1,275.00 per month. Based on the Rule of 200, Jenn’s maximum loan eligibility works out to be RM 255,000 for a mortgage.

9-Year Car Loan

Instead, if Jenn opts for 9 years, her monthly installment is RM 1,058.33. Jenn is then left with a loan installment quota of RM 1,941.67 per month. According to the Rule of 200, Jenn’s maximum loan eligibility is RM 388,334 for a mortgage.

 Loan Tenure 5 Years 9 Years Jenn’s Monthly Salary RM 5,000.00 RM 5,000.00 Assume: 60% Debt-Servicing Ratio RM 3,000.00 RM 3,000.00 Car Loan Installment RM 1,725.00 RM 1,058.33 Monthly Loan Eligibility After Car Loan RM 1,275.00 RM 1,941.67 Maximum Mortgage Eligibility  After Car Loan RM 255,000 RM 388,334

Hence, if Jenn opts for a 9-year car loan, she would be able to borrow RM 130+ thousand in mortgage to buy a property. That, I believe, is a huge drawback for Jenn who instead opted for a 5-year car loan.

## Conclusion: Should I Opt for 5 Years or 9 Years?

Personally, given the two choices, I would opt for a 9-year car loan because the pros had outweighed its cons against a 5-year car loan. As the effective interest rates for both loan tenures are similar, a 9-year car loan offers more benefits as follows:

1. Lower Installment Amount, thus, Free Up Monthly Cash Flows.

2. Save Up for Investments like Stocks and Properties or to Buy Insurance Products for Protection Purposes.

3. Preserve Loan Eligibility Amount to Buy Investment Properties.

However, like Angie, you may ask: ‘Isn’t better to be debt free quicker?’

Here is my take. Let us assume, that you have fully paid off your car loan after 5 years of servicing it. Once the bank handed you its title, you are now officially a proud owner of your car. My question is: ‘Would you continue to drive your car for the next 20 – 30 years?’

If your answer is ‘no’, I believe, most likely, you’ll get yourself a newer car, thus, applying for a brand new car loan in the future. In this case, you’ll not remain a person who is debt free once your car ages and depreciates in value over time.

So, what’s your verdict? Is it a 5-Year Car Loan or a 9-Year Car Loan?

Ian Tai

Financial Content Machine. Dividend Investor. Produced 500+ Financial Articles featured in KCLau.com in Malaysia and the Fifth Person, Value Invest Asia, and Small Cap Asia in Singapore. Regular Host and Presenter of a Weekly Financial Webinar with KCLau.com. Co-Founded DividendVault.com, an online membership site that empowers retail investors to build a stock portfolio that pays rising dividends year after year in Malaysia and Singapore.

### 26 replies to "Should I Take a 5-Year Car Loan or a 9-Year Car Loan?"

• Afiq

Really good articles about loan. Thank you and i really appreciate mr KC.

My opinion for jenn is follow the rule of thumb about purchasing a car which mean your car should value only a year of your income. In this case is rm5000 x 12 = rm60,000.

Just my 2 cent opinion

• Ian

Thanks Afiq. Good Insights.

• Syazrin Amzar

The main problem with owning taking a 9-year tenure (especially with only 10% installment amount) – after 5 years of car ownership and if you intend to sell your car, there is a high chance that the resale value of the car is lower than your outstanding loan amount.

If you don’t sell your car, you would continue paying your monthly installment + provisioning cash for major repairs of the car (especially when the mileage reaches over 100k)

My two cents.

• Chaw

Simple say, if the interest is low like about 3%, go for the 9 years, keep some cash in the pocket..
If it is high like exp 8%/9%, go for the shortest if can afford..

• Chua

IMHO The key thing is ‘keep your money in your pocket’ and discipline in spending and saving, imagine you actually have 100k cash, you can purchase your vehicle outright, or alternatively, being ‘conservative’ and ‘safe’ (let’s not talk for other type of investment) you can put your 100k cash into FD and service the loan bit by bit, also with higher loan amount and period you may bargain for better interest, you may even get that FD rate is higher than your car loan interest rate.

In the case without the cash in hand, you may still opts for 9 years, but you pay 1K monthly installment and you shall discipline yourselves to save the 0.7K into your saving/FD account, you still pay 1.7k per month like the 5 years loan, but the difference is that you have the cash in hand and after 5 years of saving, it is 0.7 * 60 = 42k, cash in hand, which you may use it to settle the loan, or if your car loan interest is actually lower than your FD rate, you may just use leave it and let it service the loan by itself until the end of 9 years or you settle the loan just to sell/trade-in your car. Plus the advantage of the flexibility to use the money in case of emergency.

Keep the money in your pocket + discipline are the keys.

Just my 2 cents.

• Steven

Hi, i think my question is relevant for both 5yr or 9yr car loan. Forgive for me for my ignorance, but is a car loan similar to a homeloan? If I make smaller, more frequent instalments that would equal the monthly instalment amount, would I be able to pay less interest and/or pay lesser number of instalments?

• KCLau

When you pay in advance, banks will give some discount on your installment. But I think you will need to walk in to the bank and inform that you are paying extra for the car loan so they can calculate the discount for you.

• IBRAHIM MOHAMED

Just curious, will you accept car loan for a government pensioner….. over 65 yrs old??

• Mt loo

Ok, I agree which should take longer tenure loan..
But I wouldn’t agree to get a Rm100k car with rm5000 monthly salary.

Perhaps. You may provide further financial advice.

• putra

What happens when you in 9 years loan but wanted to sell your car after 5 years. This is the common dilemma for car buyers

• KCLau

Actually, when the car owner want to sell the car after 5 years, the car depreciation is the same regardless of the loan tenure.

• Saiful

TQ KC Lau for the sharing. I would go for the longest of years available for any loans but it must have an insurance that would cover the loans. So, lets say if I die one day, my family would enjoy the benefits whether its early or later I die. hahaha

• Wong

If 9 yrs seems too long, why not 7 years instead of 9/5 years. Also remember to leverage on the big sum of amount that you have saved over the years on other investment like Ian shared the above, stocks, property. Property will appreciate in most cases if you choose the right investment, but car can only depreciate. I understand it’s nice to buy that beutiful car you have been wanting all these years. But also remember to think about keeping your monthly commitment low so that you can use the rest for others ie savings for marriage if you plan to, savings for parents emergency, for holiday and in case bad luck, company cut head count. All these needs to be considered. Just my 2 cents ya as I believe Jenn just want to get more opinion and more people sharing their thoughts and perspectives will help her to make the decision that she is most comfortable with.

• Alex Ho

I will take a five year car loan & invest the diffn of rm667., in a bursa listed reit ( eg: IGB Reit ). After 5 years of dollar cost averaging investment , together with the good annual dividends paid reinvested plus the share price appreciation of the reit. I am sure it will give a much better return than the interest charged of 5.64%. ?

• Alex Ho

Sorry there is a typo* – I mean to say I will take a nine year car loan. ?

• Yus Tam

It is good view on IRR, what about we take into consideration the residual value of the car (i.e resale value) after 5 year and 9 years since we are not driving the car for 20-30 years? I think it might view since the IRR between 5 years and 9 years would be much difference. Just my two cents

• Russ Chan

Car depreciates. Buy 100k car when your salary is 10k per month. If salary is 5k, buy a new 50k car and make it cool according to your style. Loan 4 years since you probably change car by then. Cars tend to start breaking down by then and will require lots of repairs. Keep your money and buy a good house with good location instead. House with good location usually appreciates.

• Cool Guy

This is awesome analysis on loan. I have to admit this is the very first time i know about IRR which is impressive. Personally i’ll go for shortest loan tenure possible where actually i’m buying off my cars by cash.

I understand the leveraging power and i admire people who play it mesmerisingly in daily life. My suggestion to Jenn is that:

It is always attractive and heart beating moment for each of us to hold our first 5k salary and thinking “how should i fully utilise it?”. The underlying logic behind this question is “one-time-purchase” eligibility. Option as below:
i) 5K – Iphone Xs Max/Samsung 10+/ whatsoever flagship smart phone.
ii) 5K – Car with loan (60-108 months)
iii) 5K – House with loan (30 years)

All 3 agenda above are correct and most people would consider. But please do not fall into the trap of cultivating so called “fake-leveraging” whereas you are actually buying things larger than you need with “leveraging loan” aka 9 years.

Think about it, you need car which can transport you from point A to B. All other things are add-on (cosmetic outlook, awesome brand, lavish material and intangible impression to friends when you step out from the car). I believe you would agree any brands out there in the market can perform the job handsomely. So the rest of the issue is just personal decision.

Take that into consideration again, would you really want to “occupy” your 5k slot with car loan (108 months long commitment, no regret allowed) or you can try to payoff debts and return to Debt-Free club for next investment venturing?

In this context i would like to emphasise that investment mortgage and business loan is totally different story because it is appreciating not depreciating item.

By owning a car (depreciating item) with cash or shortest possible loan will actually free up your slot and MOST IMPORTANTLY, refrain yourself from BAD HABIT whereas thinking everything can be leverage down to “monthly instalment”. It is always good to have same amount of money to buy a lot a lot a lot of stuffs (most of them unnecessary) but HEY! You might got layoff and stop working (no income) one day! Avoid “instalment” habit and be real to yourself especially when comes into car purchase.

Buy something you can afford, not you want.

• Danson Seng

In summary, that’s the difference of good debts and bad debts..a car definitely a liability, only depreciating in value.. Instead, the property / realty most of the time are asset which can appreciate in time with positive interest growth… Definitely a better buy.

• Millie

I will borrow the least from bank and settle loan in a short tenure if possible.
Think about the maintenance cost and wear & tear expenses of your car after 5 years if you are still repaying the loan then. It will be less burden if your loan has been settled. Or just opt for a cheaper car for more flexibility.

• John

Hi, thanks for your very enlightening article on car loan. May I know what Effective Interest Rate essentially means? What’s its difference with the normal interest rate?

• Safiq

I’ll opt for bigger downpayment, and 5 years loan 🙂

• Jordan

seems like you don understand KC article.

• z

No, he comment purely on the title itself.

• Saiful

he has a strategy. he must have done his math.

• Danson Seng

Old people mindset always want to save on interest by putting more down-payment. They never think from the other way, those down-payment perhaps can be put in better investment use with higher return than car loan.. The power of leveraging.