Here's Why You Should Say No to a Car Loan

"Exactly! Every day feels like a battle just to get to work," Parth sighed, rubbing his temples. "And with the way rickshaw and taxi drivers behave, it's even more frustrating. I just want the comfort and convenience of my own car. That's why I'm thinking of taking out a car loan."

As a financial planner, I recognised his struggle, but I was also aware of the financial pitfalls that come with that choice. "Parth, I get that owning a car seems like the perfect solution, especially in a city like ours where public transport can be a nightmare. However, taking a car loan might not be the best way to go about it."

Parth looked at me, puzzled. "What do you mean? Isn't a car loan just like any other loan?"

"Not quite," I explained. "Unlike home loans or education loans, which are often seen as 'good loans' because they help you achieve long-term goals and can appreciate in value, a car loan falls into a grey area. Sure, it can provide immediate comfort, but it also means you're committing to a significant financial burden. A car depreciates in value the moment you drive it off the lot, and the interest on the loan adds up, making it a costly decision."

He nodded slowly, taking in my words. "So, what do you suggest?"

"Instead of jumping into a loan, let's create a financial plan for you to save up for the car. This way, you'll avoid the debt trap and still achieve your goal of owning a car," I said. "It might take a bit longer, but it'll be worth it."

In a city like Mumbai, where daily commuting can take a heavy toll, having your own car seems like a perfect solution. However, as we will explore in this article, saying no to a car loan might just be the smarter financial decision. Let's continue with our conversation and understand why financing a car through a loan is not always the best option and how creating a solid financial plan can pave the way to car ownership without the added burden of debt.

"Parth, I get why you're considering a car loan," I began, as I was listening to Parth complaining about the packed trains and unreliable taxis. The appeal of having his own car was clear. "There are definitely benefits to financing a car."

"Exactly," Parth agreed, "I don't want to wait years to save up. With a loan, I can get the car now."

"True," I said. "Banks and NBFCs often finance up to 85% to 90% of the car's price, sometimes even 100% based on various factors. With pre-approved loans, you could get the money in just a day or two."

"Plus, I could get a better model," Parth added. "Something higher-end that I wouldn't be able to afford otherwise."

"That's another advantage," I nodded. "Affordable monthly instalments mean you have more choices and can go for a car that's a bit beyond your current budget. Also, you wouldn't need to liquidate your investments or sell off assets you have earmarked for other financial goals like retirement or your child's education."

Parth looked thoughtful, "But I guess there are downsides too, right?"

"Definitely," I confirmed. "One big issue is the overall cost. Lenders might highlight how manageable the monthly EMI is, but interest rates, which range from 8% to 12% annually, can add up significantly over time. Plus, there are other charges like processing fees, documentation charges, and more, which increase the loan's total cost."

Parth frowned, "So, I'm paying way more than the car's actual price?"

"Exactly," I said. "For instance, if you finance a car worth Rs 12 lakh for seven years at 9% interest, your monthly EMI would be Rs 19,307. Over those seven years, you would pay nearly Rs 4.21 lakh in interest alone, making the total amount around Rs 16.21 lakh, excluding additional charges."

Parth sighed, "And the car is hypothecated too, right?"

"Yes," I replied. "Until you finish paying off the loan, the car is technically owned by the lender. If you default, they can repossess it."

I could see Parth processing this information. "So, what do I do?"

"Parth, I understand the need for safer and more comfortable transportation, especially with the ongoing threat of infectious diseases," I said, sipping my coffee. "But we need to consider if buying a car with a loan is really worth the financial stress."

Parth nodded, "I get that, but the thought of being crammed in a train during peak hours is unbearable. It's even riskier with the new diseases and COVID-19 variants emerging."

"True," I agreed. "But have you thought about using cab services like Ola or Uber? They offer a lot of benefits without the financial burden of a car loan."

"How so?" Parth asked, intrigued.

"For starters," I explained, "you won't have to worry about down payments and monthly EMIs. With petrol and diesel prices soaring, owning a car means high fuel costs, which you can avoid with cabs."

"That makes sense," Parth said. "But what about the convenience of having my own car?"

"Convenience comes with a cost," I replied. "Using cabs also saves you the yearly expenses on car maintenance, a driver's salary if you hire one, and car insurance. Plus, if you have an accident, repair costs can be high, especially if your insurance claim is denied."

Parth looked thoughtful, "I hadn't considered that. And the depreciation of the car's value over the loan tenure is another factor, right?"

"Exactly," I said. "Over a 5 to 7-year loan period, you end up paying about 20% to 30% more than the car's original price. By the time you pay off your EMIs, the car's market value will have dropped significantly."

"But what if I need to travel frequently for medium or long distances?" Parth asked. "Cabs might not be the best solution then."

"You're right," I acknowledged. "Cabs can have their own issues like non-availability, ride cancellations, and price surges during peak hours. If you prioritise comfort and reliability over cost, owning a car might be more appealing."

"So, what do you suggest?" Parth asked.

"I'd recommend delaying your car purchase if it means taking a loan," I advised. "Instead, let's create a financial plan so you can save up for the car. This way, you avoid the extra costs and debt associated with a car loan."

Parth nodded, "Alright, let's do that. It sounds like the smarter move."

While the convenience of owning a car in a city like Mumbai is undeniable, the financial implications of taking a car loan can be significant. Using cab services offers a cost-effective alternative for short-distance travel without the financial stress of a loan. For those who travel longer distances frequently or prioritise comfort, planning a purchase without a loan is advisable. By making a solid financial plan, you can achieve your goal of owning a car without the additional financial burden.

"Parth, while getting a car loan has its benefits, buying a car with savings or a well-thought-out financial plan can be a smarter choice in the long run," I said as we continued our discussion.

"How so?" Parth asked, curious.

"Let's look at the benefits," I explained. "First off, the process is much simpler. Without the need for a loan, you skip all the steps of researching lenders, dealing with their terms and conditions, arranging documents, and waiting for loan disbursal. You just choose your car, pay for it, and drive away."

"That does sound easier," Parth admitted.

"There's also no additional cost," I continued. "Car loans come with interest and processing fees, adding significantly to the car's cost. Since cars depreciate over time, it makes sense to keep costs as low as possible. Buying with savings minimises these extra expenses. Plus, some dealers might offer discounts for cash payments."

"No EMIs to worry about either, right?" Parth noted.

"Exactly," I confirmed. "A car loan means committing to monthly EMIs for 3 to 7 years. If you face financial difficulties in the future, these fixed expenses can become a burden and cause stress."

"And I guess there are no lender restrictions either," Parth said thoughtfully.

"Right again," I replied. "Lenders often have specific criteria, such as which car models qualify for loans or who can be listed as the owner. When you buy a car with cash, there are no such restrictions. You can buy any model and in any family member's name."

"The only downside is waiting longer to get the car," Parth pointed out.

"True," I agreed. "You won't get immediate access to the car, but a solid financial plan can make the wait worthwhile by saving you a substantial amount of money and avoiding financial stress."

"So, how do I make a financial plan for this?" Parth asked, eager to learn more.

"When planning for a specific goal like buying a car, asset allocation is key," I began. "This involves choosing suitable investment avenues based on the time you have and your risk profile. Risk and return go hand in hand, so you need to balance them carefully."

I showed Parth a pyramid illustration of asset classes and explained, "Large-cap funds are relatively stable with lower risk compared to mid-cap and small-cap funds, which have higher return potential but also higher risk. Debt instruments and fixed-income products are safer but might not always beat inflation. Equity and related instruments are riskier but can offer higher returns."

"So, I shouldn't put all my money in one type of investment?" Parth asked.

"Exactly," I replied. "Diversifying your investments helps manage risk. You should consider a mix of assets to balance safety and growth. For instance, investing a portion in safer instruments like fixed deposits while allocating a part to higher-yielding mutual funds."

"What should I look for in mutual funds?" Parth inquired.

"Selecting the best mutual funds involves analysing both qualitative and quantitative factors," I explained. "Qualitative factors include the fund's portfolio quality, the manager's experience, their investment style, and the processes at the fund house. Quantitative factors involve past performance and risk-adjusted returns."

"And I need to consider my personal factors too, right?" Parth asked.

"Yes," I said. "Your risk profile, time horizon, and investment objectives are crucial. Different mutual fund categories have distinct places on the risk-reward spectrum, so you must align them with your financial goals."

"Got it," Parth nodded. "This sounds like a more strategic approach."

"Exactly," I said. "By creating a solid financial plan, you can save up for your dream car without the extra burden of a loan, ensuring a smarter and more financially sound decision."

"How can I apply this to buying a car?" Parth asked.

"Instead of opting for a car loan, let's consider a different approach," I explained. "Let's take your situation," I explained. "Instead of opting for a car loan, let's say you decide to postpone your purchase by 5 years. You invest Rs 2,00,000 as a lump sum and Rs 17,000 monthly through SIP.

"Let's break down the numbers to see how much you can grow your investments by postponing your car purchase for 5 years and investing in mutual funds with a 12% return," I explained.

"Firstly, let's consider your lump sum investment of Rs 2,00,000," I continued. "You can use PersonalFN's Mutual Fund Calculator to know the future value of your investments. Your lump sum investment of Rs 2,00,000 will grow to approximately Rs 3,52,460 over 5 years," I said.

"Now, let's use PersonalFN's SIP Calculator to calculate the future value of your SIP of Rs 17,000 per month for 5 years," I continued.

"Considering the 12% return, your SIP investments will grow to approximately Rs 14,02,274 over 5 years," I said.

"So, by investing Rs 2,00,000 as a lump sum and Rs 17,000 monthly through SIP with a 12% return, you can grow your investments to approximately Rs 17,54,734 (Rs 3,52,460 + Rs 14,02,274) in 5 years. This will help you accumulate the necessary funds to buy your dream car without the burden of a car loan," I concluded.

"This approach not only helps you avoid high interest rates and additional costs associated with car loans but also ensures that you're not financially strained. When the time comes, you can purchase your car outright without any debt hanging over your head."

"So, I could avoid the high costs and stress of a car loan and instead make a smart investment to save up for my car," Parth summarised.

"Exactly," I confirmed. "By adopting strategic financial planning, you can make informed investment decisions, paving the way for a financially secure future. This way, you achieve your goal of owning a car without the financial strain."

"Parth, I know financial planning can seem overwhelming, especially if you're not a financial expert," I began. "But that's where PersonalFN can help. They provide unbiased and honest advice on various personal finance issues impacting your investments and finances. They've been assisting clients in India and NRIs to meet their financial goals and objectives with personalised financial planning solutions."

Parth nodded, "Thanks for explaining this. It sounds like a solid plan."

To conclude:

While owning a car might give the impression of acquiring an asset akin to property, it is important to remember that a car is a depreciating asset that loses value over time. If you don't plan to use the car for frequent medium to long-distance travel and prefer not to invest heavily in something that depreciates, using cab services might be your best option. Keep in mind that if you take a car loan with a 5 to 7-year term, the vehicle will have significantly depreciated by the time you fully own it, and you may no longer find it suitable.

If delaying your purchase is feasible, creating a solid financial plan and investing in carefully selected mutual funds can be a smart strategy. This approach helps you save a substantial amount and manage your finances more effectively. However, if you cannot delay your purchase until you save the necessary amount, it is best to make the largest possible down payment and opt for a shorter loan tenure to minimise your debt burden.

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Hiral Bhuta is a Investment Consultant & Principal Officer. She is a seasoned professional in the financial services industry, currently serving as an Investment Advisor and Financial Planner at PersonalFN. With her expertise, she plays a pivotal role as the Principal Officer appointed under SEBI's amended IA Regulation. Hiral holds distinguished certifications such as Certified Financial Planner (CFP) and NISM XA & XB, complemented by a post-graduate degree in commerce (M. Com). Her primary areas of focus encompass financial planning, investment advisory, and wealth management, where she leverages her knowledge and skills to provide tailored solutions to clients. With a cumulative experience spanning five years, Hiral brings a wealth of expertise and insight to her role at PersonalFN, ensuring clients receive expert guidance and support in navigating their financial goals.
 

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.