Before Buying a Car – must answer these 4 questions.

By
Hemant Beniwal
56

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:

  1. Is a car an asset or a liability?
  2. When do you need a car?
  3. How much should you spend on your first car?
  4. 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.

Before Buying a Car - must answer these 4 questions. Click to Tweet

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:

  1. How reliable is the vehicle?
  2. What is the age of the vehicle?
  3. Will a decent repair increase the life of the vehicle?
  4. Has technology changed and your vehicle lacks it?
  5. 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.

Assumptions:

  • Retirement 2036
  • Inflation 7%
  • Return 10%

Numbers:

  • 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

buing car

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.

Numbers:

  • 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

Must ask these questions before buying a car

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.

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56 COMMENTS

  1. Nice article, Hemant.
    Though a car makes commuting easier, its not often the case for buying one. We are prone to social and peer presssure. If you subordinate gets a Alto, you must upgrade to SWIFT, that too swiftly.

      • HI,

        It’s very good, informative and real fact has been covered in this topic.
        One month befor i have purchaesd a cars , which has all this asspects.
        i am very happy with my decision.

  2. “Yes we have to as there be compelling social and aspirational reasons to buy it”
    Most young people base their decisions to buy a car only this way.

    Sometime back I made a “Think before you take a car loan” calculator. It never made sense to buy a new car, never.

    Subra’s friend once said on FB:
    ” My past 3 cars have been second hand ones. The initial erosion of value is paid for by someone else…and I get a product that is still good to go for many years.”

    If one is not frugal by choice when young, life will it enforce it when old.

    • Hi Pattu,
      Great point “If one is not frugal by choice when young, life will it enforce it when old.” makes complete sense.

  5. I bought my first car 13yrs ago that too an third hand one and used it for 10 years. I replaced it with a new one 3 years back as the production of the model was stopped and I could not get proper spares. I intend to keep the current car for the next 10 years. ( Even after 3 years it looks and drives as new as I maintain it regularly )

  6. Another craze is buying diesel car even though monthly travel is just 50-100 km only which doesn’t make sense at all. Buying diesel means you are paying hefty tax upfront (around a lac) and then trying being happy with small saving when you fill the tank.

    btw, colleagues who have 3x lower package than me are driving honda amaze, brio with hefty emi and when I bought a small 2007 model car, they are all surprised and by their looks, it seems like that I have committed a crime. I don’t give a damn but for majority of people, peer pressure certainly make them take irrational decisions.

    • Hi Jagbir,
      Good to know that you don’t care about per pressure.
      Dave Ramsey author of awesome debt management book “The Total Money Makeover” said
      “We buy things we don’t need with money we don’t have to impress people we don’t like.” I think this perfectly fits in buying a caaaar…. 😉

    • Jagbir,
      I fully agree with you. I have my peers and seniors who are stuck with expensive Mercs that they are unable to sell to get an audi and feel too bad to switch over to a mid segment sedan, all for “image”. And in the process end up being unhappy with their ‘assets’.

  7. Another similar aspect is people buying SUVs. Many people rush to buy SUVs just because they are macho looking/cool etc. What they don’t understand is how much of an SUV do they really need. The only reason one should buy an SUV is if you offroad too often (bad roads is not offroading) or you need the third row of seats (although there are SUVs with only 2 rows of seats).
    Also, with regard to features, safety etc. SUVs are far inferior to cars of the same price thereby making SUVs a whole lot expensive and not worthy of the price

    • Hi Srik,
      SUV is the fastest growing category… I am not sure about macho looks but people who keep looking for something different are attracted towards it.

  8. Interesting read Hemant! I think the best time to replace a car is when the depreciated value is good enough for you to get a good resale price. This is typically 3-4 years from the purchase of the first car, assuming by the 3rd year the depreciated value is approx 50% of the original value. Therefore, by selling in the third year, you can get a good value for your old car and use more as down payment for the new car.
    Of course the down payment depends on factors, like other loans the client already has, capacity of down payment, EMIs servicing, but generally since the loan rates for automobiles are higher than Home EMIs, it is better to put a large down payment for car loan. I would say more like 50%, with a 3 year tenure. Interest rate would be better here and the EMIs more affordable. This is just my point of view.. But excellent write up. Something we end up negotiating with our clients always.. mainly the men who want fast cars:)

    • Hi Dilshad,
      Not sure if I will agree with selling cars after 3 years but fully agree with your last point – men will be men 🙂

  10. Hi Hemant Sir,
    Great Article!I fully agree on what you said.I think that the middle class people should understand the other prime requirements like the future arrangment for the family instead of thinking of the Pear or other so called pressures.I think everybody should think about the family first.Thanks a lot!People should understand the difference between an asset & the liabilities!
    Thanks Again for the nice article.
    Sona.

    • Hi Sona,
      Buying car definitely have significant impact on other goals .. Easy availability of loans make people feel that they can afford anything but that’s not true.

  11. Great article Hemant.
    I too agree car being a liability.
    I was planning to replace my car not to upgrade but to go for auto transmission and a smaller car so my wife can also drive easily! This decision only has caused my relatives to think why I am doing this!
    And now I have decided to go for a second hand small car. Lets see how it goes.

    • Great Pradeep – this decision will add couple of lakhs in your retirement kitty.

  14. Yet another interesting post. I fully agree that having a car is a status symbol. Fortunately the car is provided by the employers in many cases either partly or fully since the EMIs and the maintenance are covered through some sort of an allowance, though this would attract the applicable Tax. I feel that the buying of car with own funds or through loan doesn’t seem to make economic sense, unless the same is required for extensive use.

    • Hi Rajan,
      That’s true that some employers provide benefits on buying cars but still people should do their calculations.

  15. it is very common nowadays to take personal loan, car loan , home loan.
    salaries are high and it is very easy to afford all loans and banks also are willing to give more.

    you cannot put price on going long drive with your lover/spouse/children.

    “those who have teeth can eat pakoda..others should keep quiet”

    • Hi Vraghavan,
      It looks you are promoting Visa card .. It’s priceless .. But we all know we have to pay price.. May be pakoras are too hot for most of the people. 🙂
      I am bit worried because you said personal loans.. It’s most expensive way to finance anything and biggest reason for getting into debt trap.

  16. Dear Hemant,

    An excellent article. I agree with you regarding the suggestion that a person should not replace his or her vehicle every 3 – 5 yrs. I made a comparison on whether to buy a new car after 5 yrs., or to continue with my current car and my assessment was that it was cheaper to maintain my current car rather than to buy a new one.

    Best Regards
    Ismail V.

  19. I purchased my first car two years ago with money I had saved (not all the savings), took a soft interest free loan from my company and the remaining financed from banker. The reason I bought car was because I never learnt riding two-wheeler and was very afraid of cab drivers/rash drivers. While I could have paid the remaining amount instead of going for loan, I reserved that for emergencies. This was brand new not a second hand as I was new to four wheeler with very little guidance to help inspect/buy a second hand.

    Cash Down – 60%
    Interest free soft loan – 20%
    Financed – 20%

    I think I made an informed decision not succumbing to any social or peer pressure. Most importantly my wife’s support was critical on making this conscious decision. We tell ourselves,
    ‘just because we have money which we can spend, does not mean we have to spend it’. Must say, had to do quite some research on closing in on a make and model considering we have more than dozen options in small cars and all competitively priced.

    I intend to keep my car for at least another 7-8 years (maintenance and disciplined driving is key).

    • Thanks Badri for sharing this .. Hope this will be helpful to other readers.
      ‘just because we have money which we can spend, does not mean we have to spend it’ this was awesome.

  20. Hello Hemant,
    This is really an eye opener article for youngster. I will just share my experience here for other reader also, I leave in Canada and weather are extreme cold for almost 6 months and you have to own a car for your daily routine, but still I am trying to manage not to buy any car and use Local Transportation system just to save Insurance amount (Insurance part is very costly in western countries). For a couple of week it is hard to adjust with local transportation but after sometimes you start enjoying travel with different people, culture as well as you will come to know geographic area of town.

    • Hi Pravin,
      Not sure how it works in cold places… Do you want to say its almost impossible to live without a car?

      • Hi Hemant
        My brother and sister live in the US. I have visited them many times. I have found that it is not possible for them to manage without cars because there is hardly any public transport system where they live. Even for purchasing groceries they have to travel long distances as there are hardly any stores within walking distances of where they live. A person who can not drive a car can not survive there.

          • Hi Hemant
            One of my relatives returned from the US recently after working for about one year there. He shared with me that the main reason of his return was that he hated driving and that he could not survive there without driving.

  21. Hi Hemant,

    You have brought up this article at the right time. I was planning to buy a new SUV for family as my current car is quite old (15 year old sedan bought 2nd hand). Although I’m buying keeping kids safety and fuel economy in mind, I might have to re-think whether I buy a brand new or a used one. Used SUV will definitely save me a substantial amount and prevent rapid depreciation.
    Article totally makes sense.

    Cheers
    Lloyd

  22. Hi Hemant,

    Very informative and knowledgeable. I found your article very impressive and practical thatswhy i joined your site.Please spare some time with me as i want to discuss about my financial plans.I know you are very busy but your valuable advise will encourage me to take right decisions.

    Satish Vyas

  24. I think with the increase in per capita income, people are buying cars. It is not the question of necessity but of a symble status. Public transport system is not reliable.This may be the compelling reason to purchase a car. One should avoid as long as he can. Liberal loan schemes to buy cars is an important aspect. When to change a car, answer is when one gets richer. In India, still there is need that socially unfortunate be looked after by providing a relible,accessible,competable public transport infrastructure.

  25. Whether to buy a car or not depends on where you live and where you have to go daily. If you live in a place where the public transportation system is good and work in a place which is well connected then you can manage without a car. When I worked in Mumbai I managed without a car for ten years.
    I now have a car and a scooter. I use scooter for short distances and a public transport for long distances. Car is only used for destinations not covered by public transport.
    For buying grocery I use a store which offers home delivery facility so that I don’t have to use car.
    I am not in favour of taking a loan for buying a car.
    My car is ten years old and I have no plans to replace it in near future.

  27. A great eye opener! First I’ll buy a truck, earn some money, then I’ll buy a SUV from the profit. I will continue using my small car till then.

  28. Very Good article, I am owning a car for close to 10 years. Still it is in very good condition. When a thought came to me to change my car, i read this article. I am thinking NOT to change my 10 year old car , If at all i change my car, I will go for Automatic model since the technology is available now a days at affordable prices unlike 5 years back.

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