Thursday, November 15, 2012

Is it Possible to Buy a Car without Car Loan?

In my childhood if some one got a car, that means he is rich. Nowadays every household got one or two cars, is it every one getting rich or are the cars becoming cheap?

If I say that a major percentage of the cars running on roads are on car loans, it will not be an exaggeration. Is it possible to purchase a car without a car loan? If I ask this question to a group, I will get different answers like, "Yes, only if I won a lottery" or "I am not rich enough to buy a car without car loan" or "It is not worth buying a car by paying lump sum amount."

There are people who's monthly salary is near to half lakhs, and still believe buying a car without loan is impossible. Well, in this post I want to analyze one scenario to find out it is mathematically possible to buy a car minus a loan without any additional burden.

This is the scenario. You want to buy a new car worth Rs 5 Lakhs. Usually the banks will finance only 80% of the car value. So, you will get Rs 4 Lakhs as loan. If you go for loan from State Bank of India, who claims providing loans with most economical interest rates, you will have to pay Rs 1699 as EMI per One Lakh for seven years at 11.25% interest rate. So, for Four Lakhs you have to pay Rs 6796.

Then what will you do for the Rs One Lakh down payment? I have seen people going for other kind of loans like Chitties or Gold Loans. This can make things worse. For this example, I am assuming that you have Rs One Lakh with you.

But, I told you I will explain how to buy a car without the loan. Imagine, you have started a recurring deposit with any bank for the same amount you pay as EMI, that is Rs 6796. Well, most banks will not accept this amount as recurring deposit, so let's round it to Rs 6800. Keep on  investing this for next 4.5 years, exactly 55 months (again rounded). Just think you are already purchased the car and paying the loan. Considering 8.5% interest rates compounding quarterly, at the end of 55 months you will have Rs 4,57,919.62 with you.

Now, invest the Rs One Lakh, which you have for the down payment, in a Fixed Deposti for 55 months at the same rate (8.5%). That One Lakh becomes Rs 1,47,035.19 after 55 months.

So, after 55 months, you will have a total of Rs 6,04,954.81 with you. Assume the price of your new car increases by 20% by this 4.5 years. So, it will worth you Rs 6,00,000. So, you have enough frunds to purchase it comfortably.

So how much you paid for this? Rs 1,00,000 + 55 x 6800 = Rs 4,74,000.

If you have gone for the loan, how much you should have been paid? 1,00,000 + (6796 x 12 x 7) = Rs 6,70,864. That means you should have paid an additional amount of Rs 1,96,864. So you have saved nearly Rs 2 Lakhs. Not a small amount, eh?

I am not considering the petrol expenses and other maintenance expenses you saved for the 4.5 years, because as you have no car now, you are paying for public transportation.

Also, I am not considering the Income Tax acquired on the interest received. In this example, you receive Rs 130954.81 as interest (including both on recurring deposit and fixed deposit). If you are in 10% IT slab, you will have to pay nearly Rs 13,000 as income tax. In that case, you will need to pay two more installment for your recurring deposit. One way to avoid this income tax is go for a mutual fund SIP, rather than recurring deposit. This can provide more returns, and you can buy the car sooner. However, understand the risk associated with it.

It is not only about money. For the 4.5 years you are paying same money to RD that you would have been paying for EMI. But is there any difference? Yes, you are still not in a debt trap. You have freedom to stop it at any time before you purchase the car. But if you stop your loan EMI, well, the bank knows how to deal with it. So, it is all about your freedom.

When you are not in debt trap, you are more armed to face any unexpected financial emergencies, like loss of job or medical emergencies. OK, I don't want to be so much pessimistic, I will say a positive benefit. At the end of 4 years, you see one opportunity to make a big profit by investing 5 Lakhs. What you can do? Postpone your car purchase and invest there. On the other hand if you are in loan trap, you will have to watch the opportunity vanishing.

So you saved lot of money, you have financial freedom, still there is one big drawback to this method. You have to wait for 4.5 years to buy a car. Your wife is not going to accept this. What if you have planned this 4.5 years ago, and started an investment from then? You would have purchased your dream car. We cannot go back in time and start a regular investment in the past, however, we can learn from this. We can start planning now for our future financial needs. If you think about your retirement after 20 years, it will be too late. Retirement, Children's education, Children's marriage - let's list all our future financial needs and start planning.

Are you thinking all these too complicated? Then the easiest and simple thing is to just check you can afford the EMI payment. If yes, purchase the car in loan. If not, wait for your next salary hike. After all, most of people are doing it, no? As I always say it is your money. You can spend whatever way you want.

Image Courtesy: Wikimedia Commons

No comments:

Post a Comment