This writing does not have any connection with the fact that sale of cars is down for the third month in row but definitely with increase in car sales in last couple of years. Buying or replacing a car is an important financial decision. Car is considered an asset by some people… (I may not agree) because simply it adds to the show off value of an individual. The expensive it is better goes the perception that you are well placed and rich. Hence people tend to make costly mistake when they have to take decision of buying or replacing a car.
Few basic questions that you should answer:
- Is car an asset or a liability?
- When do you need a car?
- How much should you spend on your first car?
- When you should replace your old car for a new one?
“Acquired my dream possession, a second hand merc c 200, 3 years old for 18 lakhs” was an sms that I received from my friend who was a banker. I knew he was earning somewhere 15-16 lakhs per annum so it means insane to spend more than your annual income on a this caaaaaaaaar. Also does his profile suits a Mercedes C class vehicle? I was about to call him but when I read the words “dream possession” in the sms I understood that calling him would make me a villain.
Is car an asset or a liability?
You know, it is in our roots to consider car an asset. For most of middle class people, car was something that was for rich people. Parents also said “I work so that we have a decent house and car during retirement”. In fact a wedding was good and well planned if one gets a car in dowry (ooo… I mean to say the well decorated car, which serves as cheer leader to people who come to attend the wedding). So car was always a distant dream. So moment you start earning your itch to get one arises. Then there is peer pressure. I have seen people directly buying a sedan, when they still have to learn car driving!!!
Just do a simple experiment. Walk into any car dealer and buy a car and get it transferred in your name and after 15 minutes, tell the dealer to cancel the deal and make refund. Ask for full amount. Will he refund 100%? No not in any case… he will offer you 15-20% less saying that he will not take it back but will arrange a buyer if you accept the discounted value. Now call in your friend circle and ask them that you have a car just one day old and you want to resale it? Will someone take it for 100% value? After all, the car is just a few hours old. I am sure no one will take it on your purchase value?
An asset is supposed to give you future earnings through price appreciation but car depreciates moment it is on road. So the basic definition of asset does not support the fact that car is an Asset. In fact this is an “essential liability” when you look at expenses associated with possessing a car.
One should buy a car or not?
So question is should we buy a liability? Yes we have to as there be compelling social and aspirational reasons to buy it. All you can do is prolong till you feel that it has become an absolute necessary. If you travel mostly alone and have no family to support you can very well live on a two wheeler. If your job involves lot of traveling within the city car can wait a bit. If your city has a good public transport you can enjoy commutation at reasonable rates. If your salary is at starting levels, you should save for down payment (if possible full payment) and should wait for the appropriate time. Usage also should be considered to go for a car or not and also to decide the size and variant (petrol, diesel or CNG/LPG).
How much to spend on a car?
Car is an experience also. So if you are new to driving, it makes sense to buy an entry level vehicle (second hand if possible) first and progress to high end on later stage. Buying a car will have two essential financial implications:
- If you buy cash down, a part of your saving will get exhausted and your liquidity will be absorbed.
- If you part loan it, you need to pay interest through EMIs. Also EMIs will bring down your monthly savings or you have to cut back few current expenses.
The basic rule is you should save for the car and buy it on cash. Buying on cash can also benefit you in negotiating price with the dealer. But if time does not permit and you have to avail a loan, stick to the principal of “maximum down payment and minimum loan amount”. The down payment means cash available freely, without much impact on emergency fund. It is advisable to avoid an impulse decision of buying a four wheeler as it provides negative impact on current financial situation. One must plan this buying decision and should accumulate the down payment in a planned way.
Also the basic principles of availing debt should be adhered to. The total EMIs including the EMIs of auto loan should not be more than 30% of the monthly income.
Owning a car is not a one-time cash outgo. You should consider insurance, maintenance, cost of accessories, fuel and repair also. Although no planning can be done for emergency repairs but yearly insurance and servicing can be covered in your financial plan.
When you should replace your car?
Lot of you are compulsory car replaces. A mental rule is made that car needs to be replaced once in three to five years. And when you replace an UPGRADE is a must. People with this thought also do not take care of their vehicle, because when vehicle demands servicing, they overlook or use cheap spares and vendors to run their vehicle.
First of all, why a replacement after 3 years? That too replacing a car which you bought on finance and paid major part of interest through the EMIs. Also upgrading means again financing, so car loan becomes and infinite loop and integral part of monthly budget.
I am not saying that you should not replace at all and stick to old vehicles. The replacement decision should be made by considering following points:
- How reliable is the vehicle?
- What is the age of the vehicle?
- Will a decent repair increase the life of the vehicle?
- Has technology changed and your vehicle lacks it?
- Has your requirement changed and require upgrade model? These can be space, fuel cost or usage.
How much it cost to buy a car
Lets take one example that how much you are going to spend on a car in your lifetime. (Here we are just talking about purchasing cost & not running cost)
Scenario 1: Let’s assume you plan to replace your car every 7th year till your retirement. You feel that you will always buy a car around Rs 7 Lakh & resale value of that will be Rs 2 Lakh. You bought your last car 6 years back so planning to replace that in 2014 so you require Rs 5 lakh. You don’t want to take loan for these purchases so will be dipping into your savings.
- Retirement 2036
- Inflation 7%
- Return 10%
- Amount required to buy next four cars in present value Rs 14 Lakh
- Amount required to buy next four cars in future value Rs 50 Lakh
Scenario 2: Now just imagine that you want to replace your car every 5th year & also upgrade it every time. You assume that resale value will be used to upgrade the car – other assumptions remain same.
- Amount required to buy next four cars in present value Rs 24 Lakh
- Amount required to buy next four cars in future value Rs 82 Lakh
Do you think this will impact your other important goals??
Thumb Rule of Buying Car
There are few rules that you can follow:
- Value of car should not be more than 50% of the annual income of the owner.
- Purchase a used car or buy a new & use it for 10 years.
- While buying car with loan stick to 20/4/10 – Minimum 20% down payment, loan tenure not more than 4 years & EMI should not be higher than 10% of your income.
You must read & share “Top 10 Financial Planning Rules of thumb”
Car will always have an aspirational value. The “the girls will always love dolls and boys will always fancy cars”. But the way you deal this financial decision makes you stress free and relaxed.
Do share your experience on how you dealt with buying and replacing your car. I will eagerly wait for your observations in the comments section on this subject.