Regular readers of my blog will know that I do not really like loans. The main reason is that it militates against my belief that we should be able to afford any asset that we are buying. A home is an exception as it is a significantly high value asset and most of us are not going to be able to buy a home without a loan. However, even in the case of a home loan I am keen that people pay it back as soon as practicable. It just does not make sense to keep paying the high interests if you have a way out.
Now while I can accept a home loan as something of a necessary evil, I am completely against car loans. The most important reason in my book for not taking a car loan is this – a car is a depreciating asset and therefore funding it through a loan over a period of time just does not make any financial sense. Let me explain it with an example:-
- Ravi wants to buy a mid size sedan for his family of 4. Though he would be happy with an entry level sedan, the suggestions from his family and friends pushed up his needs to a relatively high end one costing 10.5 lacs on the road.
- His current hatchback can be sold for 2.5 lacs and he wanted to take a loan of 8 lacs. At 11% rate of interest ( special one ) he has an EMI of 17,394 for a 5 year term.
- Ravi’s post tax salary is about 1.5 lacs per month and his home loan EMI is 50000 per month. He therefore feels that this EMI is affordable to him.
- Total interest paid by Ravi over 5 years is nearly 2.5 lacs. More importantly, at the end of 1 year itself he will be lucky to be able to sell the car at 8 lacs or so. In effect Ravi is paying 13 lacs for a car costing 10.5 lacs today, with decreasing asset value.
- In simple terms, at the high rates of interest in our economy it just does not make sense for us to fund depreciating assets through loan.
- Again, even if you do so for some very specific reason, pay it back as soon as you can.
Now, understand here that buying a car is normally nor an emergency situation and buying a particular brand or model almost never is. The easy accessibility of loans and higher disposable incomes that we see nowadays may give you a feeling that you can afford to buy it. The reality is you will be far better off if you buy a car you can afford, ideally through paying for it in full. If this amount seems exorbitant to you then you probably cannot afford it. By the time you will pay off the loan, your car is more than 5 years old and may be having some problems now. There are many newer models in the market and your family and friends are probably dropping broad hints that you need to re-look at your car.
How should you buy a car then? Well, I am completely in favour of an all cash deal, especially when you have money in debt products giving you way less returns than the interest on the proposed car loan. It is important you buy a car and model which you like, there is no point in having dissonance immediately after you have bought it. So if you are just starting off in your career today at 24, let me give you a road map.
- Let your first vehicle be a Bike if you really need one. With the transport options in some cities today, you may afford to be without one for some years.
- Target to buy your first car at 28 years or so. For this save about 1 lac per year which should be fairly easy. Initial car can be a high end hatchback costing 4-5 lacs.
- Look at buying a high end sedan in next 6-7 years when your family is probably complete. Again pay with cash after you trade in your hatchback.
- If you are really fond of cars go for an entry level luxury sedan costing in the range of 16-18 lacs when you are around 45 or so.
- Finally if you can afford to splurge later in life go in for a luxury car in the range of 40-50 lacs or more. This could well be wishful thinking though.
Of course, a better way can be to not buy a car and get your company to give one to you as part of your compensation. If you are lucky to be in such a position, that is the best deal. If not , follow the mode suggested in the post.