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

Ian Tai is the founder of Bursaking.com.my, a platform that empowers retail investors to build wealth through ownership of fundamentally solid stocks. It is an essential tool that sifts out stocks that grow profits consistently from a database of over 900+ stocks listed mainly in Malaysia.

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

• 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 🙂