When to take out a bank loan to buy a car?

As a youngster who moved to Delhi from a small town, Vaasu always wanted to drive his own car. It has now been five years since he started working in Delhi. Promotional campaigns for cars always grab his attention and he thinks he should buy one soon. He gets Rs 50,000 as net salary after all deductions and taxes. His bank is prepared to grant him a loan of Rs 7 lakh, repayable over five years with a monthly payment of Rs 15,500. What will be the implications of this decision on his finances?

Vaasu’s loan will represent around 30% of his take-home pay, leaving him little room for other loans. If he has to take out a personal loan, a student loan or a home loan, his large car loan will be a brake. If he is sure he does not plan to take out other large loans immediately, he can go ahead with car credit.

The fixed nature of the monthly payment means that as Vaasu’s take-home pay increases, the car loan will become a smaller percentage of his income and leave room for more loans if needed. Vaasu must consciously build this free space by not taking too many loans in the meantime. If compulsory expenses (rent, groceries, bills, etc.) occupy about 60% of his income, after the car loan, he only has 12% of his income in savings. Disciplined investment of savings is necessary to balance one’s assets. A car is a depreciating asset, the resale value of which will be much lower than its cost. If he invested some savings in asset appreciation, even while servicing his loan, he would have created a buffer. If necessary, it can borrow against other assets it owns.

It is not always necessary to withhold and save every rupee. Vaasu should indulge himself and feel happy that he bought his car. He just needs to make sure that he gives himself the space and time to earn and save for a period of time, before he needs another loan from his bank.

The content on this page is courtesy of the Center for Investment Education and Learning (CIEL). Contributions by Girija Gadre, Arti Bhargava and Labdhi Mehta

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