The Most Authentic Guide on Personal Finance and Investments

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Should I borrow Rs.5 lakhs with salary Rs.50K p.m.?

Last week I received a query from one of my blog subscribers.

Rohit was planning to buy a new car. The on-road cost was working out to about Rs.6.50 lakhs. His idea was to pay Rs.1.50 lakhs as down-payment from his annual bonus and finance the balance Rs.5 lakhs through a car loan.

With a total salary of around Rs.50,000 per month, Rohit was wondering whether borrowing Rs.5 lakhs for the car was Ok or not.

To arrive at the correct answer, let us analyze the impact of this loan on Rohit's day-to-day finances.

The bank was offering the car loan to Rohit on the following terms:
Amount : Rs.5 lakhs
Interest Rate : 11.50%
Tenure : 4 years

Based on the above terms, the EMI worked out to Rs.13,044 per month.

Though Rohit earned a monthly income of Rs.50,000, after various deductions his take-home amount worked out to Rs.44,500.

Rohit has no other loan liabilities. Accordingly, with the above car loan, his Debt-to-Income ratio (DTI) would be 29.31% (= 13,044 / 44,500).

It is strongly advised that borrowing for car (including personal loans and credit card outstanding, if any) should be such that the total EMI does not exceed 20-25% of net take-home income. [Refer 'Five minutes to check whether you should become a Borrower' for the prudent levels applicable to different types of loans.]

Thus, with 29%+ DTI it was not advisable to borrow Rs.5 lakhs.

I gave Rohit two alternatives.

Alternative 1 (Preferable)
One option was to increase the down-payment from Rs.1.5 lakhs to Rs.2.25 lakhs.

This would reduce his monthly EMI to Rs.11,088, giving a manageable Debt-to-Income ratio of 24.92%.

Alternative 2
The other option was to increase the loan tenure from 4 to 5 years.

This would reduce his monthly EMI to Rs.10,996, giving a DTI of 24.71%.

Rohit had a question... why alternative 1 is better? 

For this, let us look at overall how much money would go out of his pocket.

Alternative 1: Rs.2,25,000 + Rs.11,088*12*4 = Rs.7,57,216
Alternative 2: Rs.1,50,000 + Rs.10,996*12*5 = Rs.8,09,778

Hence, given that one saves more than Rs.50,000 under Alternative 1, it is the clearly the recommended option.

[By the way, under the original terms, the total payout would have been about Rs.7,76,136 (= Rs.1,50,000 + Rs.13,044*12*4)]

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