Purchasing A Car: Does Buying With Cash Trump Car Loans?

Using cash instead of taking a Car Loan always has more advantages. However, in the present scenario, a Car Loan might make more sense, especially if you are self-employed.

Ever borrowed someone else’s knife to cut up that sinful chocolate soufflé cake? The lender of the knife usually ends up with a fair bit of the cake when you return the knife. Car Loans are much like that – lenders usually give you a loan and get a chunk from you in the form of interest.

So, this being the scenario, should you buy a car using cash or does it make better sense buying it using a Car Loan? Of course, using cash is the best way forward most of the times. But at present, with loan rates falling, a Car Loan can actually help, especially if you are self-employed. Even if you are salaried, you can turn it to your advantage. Want to know more? Read on.

Mohan, a salaried individual, just received a fat bonus of Rs. 7.5 lakh. He wants to buy a car. Some of his friends recommend taking a loan, having bought their car that way, while others are trying to convince him to use up his bonus. What should Mohan do?

Additional Reading: Drive Away With These Instant Car Loans

CASE 1: SALARIED AND INVESTING IN A FIXED DEPOSIT

If Mohan opts for a loan, he would have to make a 20% down-payment and will get a loan for only 80% of the car’s value. Furthermore, a loan for 3 years at an annual interest rate of 12% and EMI will come to Rs. 19,010 every month. As Mohan has to make only a 20% down-payment, he is left with Rs. 6 lakhs, which can be invested. Assuming that Mohan earns a post-tax return of 10% per annum on this investment of Rs. 6 lakhs, this amount would have grown to Rs. 8,06,934 in 3 years’ time. The table below gives you the net cash that Mohan will have at the end of 3 years if he opts for a Car Loan to fund his purchase and invests most of his bonus in a Fixed Deposit.

It is seen that Mohan incurs a higher cash outflow than inflow over 3 years if he opts for a Car Loan and invests in a Fixed Deposit.

CASE 2: SELF-EMPLOYED AND INVESTING IN FIXED DEPOSIT

If Mohan was self-employed and opts for a Car Loan, he would still have to make a 20% down-payment and will get a loan for only 80% of the car’s value. Everything else will remain the same except the fact that he can claim tax deduction for the interest payment on the Car Loan. This is applicable if he registers the car in the name of his business. The table below gives the net cash that Mohan will have at the end of 3 years, if he opts for a Car Loan to fund his purchase and invests most of his bonus in a Fixed Deposit.

Additional Reading: Use Your Fixed Deposit To Get A Car Loan

As is evident, Mohan has a big advantage when he takes up a Car Loan when he is self-employed.

CASE 3: SALARIED AND INVESTING IN MUTUAL FUNDS

Here, everything will remain the same as in case of Mohan being salaried and the investment amount. The only difference being Mohan will invest in Systematic Transfer Plans (STP) of Mutual Funds instead of Fixed Deposits. STP is where you invest a lump sum in a Debt Mutual Fund and transfer the money to an equity Mutual Fund periodically.

Mohan is investing Rs. 6 lakh in a Debt Mutual Fund that earns 8% per annum and transfers Rs. 19,000 to an equity Mutual Fund every month. The idea is to earn more with lower risks. Under the Systematic Investment Plan (SIP) your amount will remain in a savings account that will earn you just 4% per year whereas in an STP your amount remains in a Mutual Fund (as safe as FD) that could earn you double that amount.

Assuming that Mohan earns a post-tax return of 17% per year on this investment, this amount would have grown to Rs. 10,38,566 in 3 years. The table below gives the net cash with Mohan at the end of 3 years if he opts for a Car Loan to fund his purchase and invests most of his bonus in a Mutual Fund.

Additional Reading: Conditions To Prepay Your Car Loan

Mohan is able to save quite a bit of money when he opts for a Car Loan and invests in Mutual Funds at the same time.

Here’s a comparison. If Mohan had chosen to make an all-cash purchase, he would have saved the interest payment of Rs. 84,364 on the Rs. 6 lakh Car Loan. If he thinks he can put his cash to better use by investing in Mutual Funds he can earn as much as Rs. 2 lakh in 3 years. A car being a depreciating asset won’t give you returns.

What’s The Conclusion?

Taking a loan to buy a car does not make sense if you are salaried and invest in products that earn low returns. However, if you have a cash crunch, haven’t saved up or if you get low Car Loan interest rates and are willing in invest in products that give high returns, taking a Car Loan may be the answer to buying your dream car.

Moral of the story: You can have the cake and eat it too if you know how.