Three years back Rahul (Name Changed) started his career in a Telecom company as Assistant Manager, with a good salary package. Like many new entrants in financial life, he was also of the view that now the World is in his pocket and he can live the way he wants and have a lavish lifestyle with no tensions on asking pocket Money from parents. But here destiny has some other plans, as his father was my client and he directed him to me to have an understanding on how finances works and how he should manage his money. 🙂
We met in a coffee shop so that he should feel more comfortable in his known surroundings. His girl friend, Saloni (name changed, now his wife) also joined this discussion. Saloni was quite focused and unlike Rahul was very much interested in listening to what I wanted to put across. Besides the general discussion on Budgeting, cash flow management, insurances, retirement and goals, the specific discussion that we did was on Buying a CAR. As Rahul was earning good so he would not find difficulty in getting loan but I specifically told them that being Car a depreciating asset which loses its value the moment it comes out of showroom and also keeps on dropping with time, he should not go for a Car loan. Paying interest for a depreciating asset means that you are losing money from 2 sides (Depreciation and Interest) which is not a good idea. If at all they want to go ahead with some vehicle immediately, its better to save for 3-4 months and buy a good Motor bike. Also they should start saving some amount every month with the Car’s goal in mind. Rahul was reluctant as he didn’t want to wait for 2-3 years but Saloni convinced him. Well, Women Power and Influence played the part.
Now last month they get married and yesterday they called me again to have a detailed discussion on their goals and future investments, this time with a more serious and well directed approach. They themselves insisted to visit my office so we can have a focused discussion. Saloni has completed her Interior designer course and will be starting with own consultancy few months down the line.
After having discussion on other financial planning things we again went back to the years old issue of buying a CAR. Now they have saved Rs 6 lakh for that goal. But this time the question was different. As in the past 3 years, rahul understood the meaning of Saving for a goal, and now even when they have accumulated Lumpsum money for the same, they are a bit reluctant to part with the savings and again asking me to approve the decision to go for a loan and invest this savings somewhere else. Rahul said that his company has got some tie up with a bank and they will provide him loan on concessional rates of around 10% with no processing charges. So the Offer was looking quite attractive. Now I did some calculations which I wanted to share with all of you to explain the reason of not buying the car on loan.
For a loan of Rs 600000/- with 5 years tenure @ 10% p.a interest reducing per month, he has to pay EMI of Rs 12748.23.
Now with these EMI payments the yearly Interest that he’ll be paying to bank will be as follows:
|Year||Total Yearly Interest|
|1Let’s Get Good With Money|
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If he buys car on loan assuming that he’s not paid any processing charges or any other cost, he’ll have to pay Rs 1.65 lakh as additional cost, besides the depreciation that he pays indirectly. If I adjust depreciation @15% p.a then after 5 years Car value would be Rs 2.66 lakh. This shows that he’s losing money on 2 fronts. Though he cannot do anything for depreciation but by buying CAR on cash he can save on the Interest payouts.
Now, they come up with another option, which says if park their money in some safe instrument generating some income and keep on servicing the Car loan by withdrawing the EMI amount every month. This will help in maintaining the liquidity and also No EMI burden will affect their other savings.
To use this option they need to invest in some liquid mutual fund with an expectation of acceptable rate of return. I think one can assume Pre tax rate of 8% p.a. Also one has to understand that car loan rate does not come with floating rate option. So liquid fund investment may not return 8% Y.O.Y but car loan will have to be paid at 10% fixed.
This alternative option will generate around Rs 35000/-(for highest Tax bracket), which has no doubt reduced the total out go but is still a way below the total interest amount.
Rahul came up with the Third option. If they invest this lumpsum amount in some long term instrument like equity mutual funds for their long term goals and take Loan on Car.
This option has to be evaluated keeping in mind the cash flow situation of family and other arrangements required for savings, insurances, vacations etc. If the cash flow position is not getting properly managed then many “so called” Long term savings gets broken in between to satisfy short term wants.
For salaried class buying Car on Loan is a very bad idea. Financing option works when the buyer is into some business and also comes in Higher Tax bracket. A business person can claim the interest payment and the depreciation as business expense and thus reduce his tax outgo. (Check sheet 2 of Calculator)
In this particular case I advised Rahul to gift total amount to Saloni and buy car in her name with 100% downpayment, as she’s about to start her consultancy business and can claim the benefit of depreciation. And whatever they want to pay as EMI should be invested monthly as per the goals and asset allocation advised.