With the increase in car prices, interest rate hikes and rising fuel costs, the cost of car ownership has gone up a lot in India over the last couple of years.
Many who suffer heavy road traffic daily will tell you that owning a car is of not much use. But there are still millions who still want a car and many for whom car is a necessity.
So how should you go about buying a car? Should you take a car loan and purchase it immediately? Or delay a bit, save some money (and reduce the loan), and buy it later?
While it is easy to be lured by small EMI options and be tempted to buy a car which is bigger and costlier than what you need, that too immediately, what is the right thing to do? Let’s discuss the pros and cons of either approach.
Taking a car loan
If you don’t want to delay your car purchase but don’t have all the money you need, then you will need a car loan. This also means you need to have the money for the downpayment.
Say you want to buy a car that costs Rs 12 lakh today, then you need to have money that is sufficient for the 10-15 percent downpayment demand of the lender. You need Rs 1.2-1.8 lakh for a downpayment.
Now comes the actual loan part. Car loans are generally for 3-5 years.
For a Rs 10 lakh loan (assuming you already made Rs 2 lakh downpayment) at 9 percent for a four-year loan, the monthly EMI would be Rs 24,885. And the total interest would be about Rs 2 lakh over four years. This is the extra amount you pay over and above the original Rs 12 lakh car cost.
Now the car is a depreciating asset and loses value from day one. So, you are paying about 20-25 percent extra in interest to buy something that is losing value each day. You also don’t get any tax benefits for car loans (like you get for home loans).
Note – Do not use up all your savings to purchase a car. Always keep some money at hand for emergencies.
I know what you are thinking – we can’t just look at a car from a number perspective. It has utility and it can make life easier if you need to move around a lot. It also gives you pleasure (assuming you like driving and have the time). But we are not disputing whether buying a car is a good idea or not. We are comparing whether it makes sense to take a loan to buy now or save some money first and then buy later.
So coming back, let’s see the alternative.
Saving First & Buying Car Later
If you, for any reason, need a car immediately, then this option will naturally not work for you. It is for those who are not in a hurry to buy a car. And delaying your decision a bit, saving some money first, and then buying it using the savings can be a wiser choice.
Let’s continue with the previous example. You want to buy a Rs 12 lakh car, you already have Rs 2 lakh (that was used as downpayment earlier). You can also save Rs 24-25,000 monthly as you were previously willing to pay an EMI of the same amount.
Let’s see how much you can save that way –
• A Rs 25,000 monthly SIP at 7 percent for 3 years will give about Rs 10 lakh
• A Rs 25,000 monthly SIP at 8 percent for 4 years will give about Rs 14 lakh
• A Rs 25,000 monthly SIP at 9 percent for 5 years will give about Rs 18 lakh
Note - Assumed nil equity allocation in 3 years and slightly higher equity allocation in tenures of 4 and 5 years resulting in higher return expectations.
So if you decide not to take a loan (and also delay buying the car), then you can invest for a few years and accumulate an amount which will be more than what the car costs then (even if you consider inflation). All you need is some patience.
What if I don’t want to wait for so long?
That’s natural to feel. On one hand, you can get a brand-new car immediately. On the other hand, is the slow option to wait for a few years and then buy a car.
You can always take a middle path in this.
Instead of making a 10-15 percent downpayment now versus buying a car a few years later with 100 percent loan-free payment, you can target trying to save up at least 50-60 percent of the car cost and then go for a loan. By then, your income would have also increased and you could afford a higher EMI (and shorter tenure) to save up on interest costs. You can also use a thumb rule that car loan EMI is not more than 10 percent of your take-home pay.
That said, remember that a car is a depreciating asset and hence, it’s better to take as small a loan as possible. There is a mathematical case for buying a car using your savings instead of taking a car loan. But at the end of the day, it’s your decision to make.
