“This festival season welcome a new member to your family” read one of the advertisements in today’s newspaper. From the first glance, i thought it to be an ad for some maternity home or matrimonial website. Surprisingly, it was an Advertisement of Car Loan from one of the leading banks in India. During my childhood, the car was luxury/aspirational/premium purchase. For 9 out of 10 households, the first car was Maruti 800. During those days, the car loan interest rate was too high. If i remember correctly, my father took car loan at 18%. The marketing was focused around “upgrade from 2 wheeler to 4 wheeler”. Therefore during old times the car loan was required for upgrade from 2 wheeler.
Nowadays, the marketing communication shifted to premium segments like SUV, XUV or Premium hatchback. Today also car buyer avail car loan to upgrade but to upgrade from small car/hatchback to premium segment :). These days driving a small car is like you are driving a 2 wheeler. On a lighter note, one of a friend in Delhi bought a 20L premium car on car loan just because her friend bought 17L XUV. I am waiting for her friend to upgrade to 25L luxury car :).
In one of the earliest posts, i suggested the readers to Avoid Car Loan and Lease the Car. A lot has changed in last 5-7 years. Sometimes, i feel that cab services like OLA and Uber are much cheaper compared to the cost of owning a car. My thought process is from a personal finance perspective. From a family perspective, you definitely need a car :). In my opinion, the car is a utility vehicle depreciating in nature. It should be bought only from savings/fund sources. As a last resort, You may utilize your annual performance bonus to purchase a car. But purchasing a vehicle on loan is a BIG NO and financially unwise decision.
In my friend’s case, she could have bought a mid-segment car without availing car loan. Unfortunately, peer pressure and good marketing by auto company & loan pitch by bank pushed her to stretch budget from 7L to 20L. I suggested her against car loan and shared some of the reasons for the same. In this post, for the benefit of readers, i will discuss same 7 reasons as i shared with my friend.
Car Loan – 7 Reasons Why Should Avoid Hypothecation To Buy A Car
1. Car is not an Asset but it is an Expense:
Though financial planners consider the car as a depreciating “asset”. In my posts, i follow the same terminology to maintain uniformity but it is not correct. The basic definition of an asset is “An asset is an item of economic value that is expected to yield a benefit to the owning entity in future periods“. In layman terms, the asset is something that is appreciating in nature like property, gold, investments etc.
The value of the car depreciates by 30% immediately it is out of the showroom. On an average, 3-year-old car’s depreciation is 50%. The real depreciation is much high if you add interest cost to the on-road value of the car. At the same time, you can also find a lot of posts/blogs on the cost of owning a car including running cost.
In my opinion buying an asset on loan makes sense from a personal finance perspective and the car does not qualify in this category. A car loan is similar to buying a stock on a loan wherein we know in advance that stock will definitely drop by 50% in next 3 years. Will you invest in such stock? If the answer is NO then the same applies to car loan also. On the contrary, i do understand the car is a must because of the convenience factor for the family. Therefore, you can buy a car with the high resale value and from savings.
2. The Real Cost of the Car:
For any type of mortgage, it is important to calculate the real cost by including interest cost in the cost of the product/service. For example, if i am buying a car of 7L. I avail 85% car loan i.e. 5.95L @ 10% for 48 months. I am assuming average repayment period though the repayment period can extend up to 84 months. Always remember that longer repayment period means higher interest outflow. Therefore, it will further increase the real cost of the car.
In the example shared by me, the interest payable will be approx 1.29L. Therefore, the real cost of the car will be 8.29L. By availing car loan, i increased the cost of the car by approx 18%. In the case of a home loan, the property appreciation, and rental value neutralizes the interest cost. Unfortunately, it is not true in the case of a car loan.
3. Steep Part payment / Foreclosure Charges:
Different banks use different terminology so borrower gets confused. For simplicity purpose, if you are pre-paying a part of car loan then it is part payment / part prepayment. On the other hand, if you are paying off your car loan entirely before the end of repayment period then it is foreclosure / full prepayment.
In the case of a car loan, the part/full prepayment charges are quite steep. In certain cases, it might be beneficial to continue with the car loan instead of part payment or foreclosure. The charges may vary from bank to bank. Under special offers, sometimes these charges are waived off. Certain banks don’t allow prepayment or foreclosure for 6 months/1-year-old car loan. Besides that you cannot prepay beyond X% of loan amount subject to a max limit of 25% of principal outstanding during the year.
Typically, the foreclosure charges are 5% of principal outstanding or interest outstanding for remaining loan tenure (Whichever is lower). It does not make sense to foreclose the loan by paying interest outstanding as foreclosure charges until unless you are selling the car.
4. No Income Tax Benefits attached:
Unlike a home loan, there are NO tax benefits attached to a car loan. Tax benefits bring down the net interest rate. For example, in my case, after adjusting the home loan tax benefits, the net interest rate of home loan reduced from 10.25% to approx 7.8%. It is not true in car loan thus the net interest cost of a car loan is high.
5. Impacts CIBIL Score negatively:
A car loan is a low-value loan compared to your salary. There is a paradox e.g. if approved loan is high it means your income is high. The million dollar question is if your income is high then why you availing car loan. It is understandable in the case of home loan as the property is high ticket purchase but it is not the case with a car loan. Normally, the approved car loan is 6 times your monthly salary/income.
Therefore, it implies that borrower is not able to manage the finances well. If you look at it differently, considering 30% average savings rate in India. You can save for car purchase from your income in 18 months. If you are finding it difficult then something is wrong somewhere. In case, you are planning a home loan in next 3-5 years then it is not advisable to avail car loan as it impacts CIBIL Score negatively and may decrease your future loan eligibility.
6. Miscellaneous Cost is HIGH:
The banks charge processing fees between Rs 3000 to Rs 5500 for a car loan. Besides processing fees, there are various other charges like documentation charges, stamp duty, loan cancellation charges etc. Therefore, as a borrower, you should calculate the miscellaneous cost before finalizing the car loan provider.
Also remember that any type of loan increases the affordability factor for a borrower. The increase in affordability comes with indirect costs attached to it. For example, i can afford a small car without any loan requirement. Because of easy availability of loan, i upgraded to premium segment or XUV. It will also increase my maintenance and running cost. The mileage will be less and cost of maintenance will be high. This is hidden/indirect cost you pay for the car loan.
Personally, i feel that Hypothecation is an another drawback. Removal of Hypothecation is a big hassle especially if you shift cities due to professional compulsion. Another hassle is that you cannot sell the car till it is hypothecated. After loan closure, You need to approach the RTO office in which the car was registered along with bank NOC and they will issue a new RC.
Words of Wisdom:
From a personal finance perspective, it doesn’t make sense to buy a car on loan. As it is depreciating “asset” therefore it is advisable to save and then buy from own sources of fund. Secondly, you should always buy a car with good resale value else it can be a wealth destroyer.
Copyright © Nitin Bhatia. All Rights Reserved.
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