In the previous post, Alvin has done a comprehensive breakdown of the car ownership costs in Singapore. It is a must read for anyone who is contemplating buying a car.
I will add on to that and try to answer two common questions car buyers ask.
1. What is the depreciation of a car? How do we calculate depreciation? Why is depreciation important?
2. How is the interest rates for vehicle loans calculated? Are car loans actually more expensive than housing loans?
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Depreciation is defined as a reduction in the value of an asset over time. A car in Singapore is without a doubt a depreciating asset for a very simple reason – the Certificate of Entitlement (COE).
The lifespan of a car is limited by the COE. When the COE runs out, you either renew the COE or scrap the car. For the purposes of this discussion, let us consider only the second option.
For all cars that are less than 10 years old, there will be a Preferential Additional Registration Fee (PARF) rebate payable upon deregistering the car. Most dealers are able to provide the amount if you ask. If not, check out the PARF rebate calculator here. This is also commonly known as the residual value or the scrap value of a car.
Simply put, total depreciation is the amount you pay for a car minus the amount you will receive at the end of car life. We are interested in the annual depreciation so we will need to divide that amount by the number of years the car will be in service.
Let us take the example of a very common car. The Toyota Corolla Altis (Classic) is currently retailing at $112 888. The scrap value at the end of 10 years is $8850. Assuming one buys the car brand new and uses it for 10 years, the total depreciation would be $112 888 – $8850 = $104 000. Per year, the car will lose $10 400 in value. Taken it another way, it will cost $10 400/12 = $867 per month just to own the car even if you do not use it the entire month.
At this point, it is important point to note that depreciation is different from the monthly installment amount. The amount assuming a repayment duration of five years and an interest rate of 1.48% is $1212 per month.
Installment depends on a few factors, including the loan quantum (the larger the down payment, the smaller loan required) and loan tenure (the shorter the loan duration, the larger the amount required every month).
The amount you have to pay for installment every month is a good gauge of affordability. The amount the car depreciates is a good gauge of value.
To illustrate that, let us look at this 2009 Corolla Altis retailing on sgcarmart which I have randomly picked.
I put the numbers side by side for comparison.
|Brand New Altis||2009 Altis|
|Purchase Price||$112 888||$60 800|
|Time Remaining||10 years||4 years|
|Depreciation||$10 400||$12 968|
|Downpayment||$45 155||$24 320|
For someone on a budget, the older vehicle makes more sense – the initial down payment and the monthly installment are both lower. Hence it would cost less to purchase and finance the vehicle.
There is a price to pay though. Assuming the owner intends to keep both vehicles to the end of their COE, the depreciation is actually less for a new car than the used. Brand new, the Altis will lose $10400 per year while the used vehicle will lose almost thirteen thousand annually. It is not hard to see that the new car is of a better value.
How are Car Loans calculated?
Vehicle loans are calculated in different manner as compared to housing loans. Let us examine them in detail.
Most housing loans are calculated on a monthly rest basis. As you make payment towards the loan, the principal amount reduces. Interest rates are calculated based on this reduced amount.
To illustrate, assuming you have taken up a $500 000 housing loan at a 3% interest rate. For simplicity, let us assume that the interest is calculated on a yearly rest basis, and that the principal reduces yearly. For the first year, the interest payable would be $500 000 x 3% = $15 000. At year 30, the interest will be calculated based on loan remaining, which will most probably be a very small sum. The interest payable towards the end of the loan will become negligible.
Car loans are calculated on a flat rate basis. The interest rate is calculated upfront based on the total amount and the tenure of the loan. The amount of interest is calculated based on the initial loan amount and it is charged upfront. It does not reduce as the years go by.
To illustrate, let us assume a car buyer taking up a $100 000 car loan at 2% interest for five years. The interest payable is easily derived. It is simply Principal x interest x tenure which works out to be $100 000 x 2 % x 5 = $10k.
MoneySense has a good article comparing between advertised interest rates and effective interest rates. It is a must read for anyone considering a car loan. Despite the advertised interest rates being as low as 1.48% for car loans, the effective rates are much higher.
There are a number of sites that allow you to compare between the two. I have used moneycamel and here are some numbers for comparison. Based on a loan quantum of $100 000 payable over five years, if the advertised rate is 2%, the effective interest rate is actually 3.8%. If there advertised rate is at 3%, the effective rises to 5.64%.
Car loans that look cheap at first glance may not be so cheap after all.
Buying a car is a major financial decision. The numbers and process might seem complicated at first, but with a little bit of effort, you will be able to navigate through them. Understanding depreciation and how car loans are calculated is the very first step.
As the amount is substantial, making an informed car buying decision will make a lot of differences to your finances over the long run!