One of the first things you need to look at while taking a car loan is the monthly installment, popularly known as the Equated monthly installment (EMI). While different banks would give you different quotes depending upon their rules and regulations, you must compare your monthly outflow for the same amount and for the same tenure. Remember that the effective interest rate is a function of the reducing balance method being used to calculate it. Reducing balance is the method of reducing the principal amount being repaid, from the outstanding loan amount. Every time you make a payment, the interest you pay is calculated on balance outstanding principal. Different banks can use different methods like:
Daily : In this method, the principal is reduced every day as if you were making repayment of the principal on a daily basis.
Monthly : In this method, the principal on which you pay interest reduces every month, that is, when you pay your EMI.
Quarterly : In this method, even though you keep on paying you EMI, the principal reduces only every three months.
Yearly : In this method, the principal is reduced finally, at the end of each year. This effectively implies that though you have paid back a part of the loan during the year, the principal outstanding gets reduced only at the end of the year. This simply means that the earlier the principal reduction is done, the lower the amount you will pay to the bank.
Nowadays, almost all banks offer the daily reducing method as it has more or less become a norm in the industry. However, it is better that one is aware of such things while going for a car loan.
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