On depreciating assets, Warren Buffet had the following to say to those hoarding cash. “Today people who hold cash equivalents feel comfortable,” Buffet said. “They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value.” Consider the converse: if you own many appreciating assets, you’ll be on the fast track to being wealthy.
Cars today are necessities for many families. Gone are those days when cars used to be an expression of wealth in India. With unreliable public transport, extreme weather, hostile traffic, and exposure to pollution, it’s vital for many families to have cars to get around the town. That still leaves us with the difficult question regarding car ownership which requires you to put several lakh rupees in a depreciating asset.
Cost Of Car Ownership
Let’s understand why cars are considered a depreciating asset. You may buy a typical hatchback for around Rs 5 lakh. You take a loan of Rs 4 lakh for five years at an interest rate of 9%. Your EMIs are Rs 8,303. In five years, you will repay about Rs 4.98 lakh. There will be additional costs of insurance, maintenance, and fuel. Over five years, you’re looking at a total ownership cost of around Rs 7 lakh, or nearly Rs 12,000 a month. However, if you try to sell your vehicle after five years, you’re likely to receive half of what you spent – or maybe even less. This is due to wear and tear, damages, or any performance related issues all of which make the car less effective. This, of course, doesn’t account for the utility, which the car will provide your family. The joy you will derive from your car is not quantifiable. But, if you had put Rs 12,000 in an equity mutual fund SIP earning a CAGR of 12%, you would have a corpus of Rs 9.9 lakh in only five years.
What To Do
As I said earlier, buying a car may be a necessity for you. Therefore, don’t let the financial downsides discourage you. However, you must look to reduce the cost of ownership meaningfully. This way, your car loan would pinch your pocket less and free up more of your money to be directed at wealth creation or paying off of debts. Here are a few steps to take in this regard.
Compare Loan Options: When you land up at a car showroom to find your set of dream wheels, you may be presented with loan options with the promise of hassle-free paperwork and instant approval. Such options may have their merits. But never take a loan without doing your research and comparing your options. Go online, check the loan options available to you. You should compare not just interest rates, but also processing fees, repayment fees, and foreclosure terms. Picking the right loan can help you save tens of thousands in the case of a car loan. Loans being long-term arrangements, always read your terms and conditions. Never be hurried into signing the dotted line.
Prioritise Loan Payments: It’s likely you may have other debts to repay along with your car loan. You may have a home loan, a personal loan, or credit card debt. Repayment of debt is a serious matter and due attention should be given to it. Being on top of your repayments can potentially help you save money in the long run. Car loans have a marginally higher interest rate than home loans. Therefore, you should aim at clearing your more expensive debt first.
Take A Lower Tenure: The longer your loan tenure is, the smaller your loan EMIs will be. But smaller EMIs can also mean higher interest out go. Let’s understand this with an example. If you borrow Rs 400,000 at 9% for four years, your EMI is Rs 9,954. Your total repayment would be Rs 4.77 lakh. If your tenure is seven years, your EMIs will be just Rs 6,436, but your total repayment would swell to Rs 5.40 lakh. You should aim at the lowest tenure possible since this would help you reduce your interest outgo and get out of debt quicker.
Part Payments: By making pre-payments meaningfully, you can finish your loan sooner and reduce your interest payments. Let’s understand this better. Suppose you have a car loan of Rs 4 lakh at 9% for seven years. Your total interest will be Rs 1.40 lakh. After 24 EMIs, you pre-pay Rs 50,000. Your loan tenure reduces to 73 months (from the original 84), and your total interest payment also reduces to Rs 1.15 lakh. However, to pre-pay your loan, you must ensure that the loan allows you to do so. Some loans may also charge you for pre-payment. These terms and conditions must be ascertained clearly before you enter the loan agreement. You don’t have to strain your monthly income or take a loan to pre-pay. Look to do so through smarter options, such as with your annual bonus or seasonal windfalls such as cash gifts on Diwali.
Pre-Closure: Closing a loan before its full tenure can significantly reduce your interest outgo. However, before you exercise this option, take note of the pre-closure penalties and terms and conditions, which may sometimes not be in your favour. For example, one lender offers zero foreclosure penalties after 24 EMIs or 50% of the loan amount.
Repaying your car loan quickly can turn your depreciating asset into a cost-efficient asset. Take stock of your debt periodically, and keep taking steps to minimise it.