We Design Your Financial Destiny

(Precious) Words of Wisdom : "Wall Street makes its money on ACTIVITY, you make your money on INACTIVITY." ~ Warren Buffett

How Much Should I Borrow To Buy A Car?

Unlike in the past, buying things on loan has become quite common. People are no longer willing to wait till they have saved enough money to fulfill their desire(s). There are so many financing options available today.

However, going overboard with your loans can have (very) serious consequences.

Therefore, before you sign on the dotted line on your loan application form... pause... and ponder.

Am I borrowing too much money?
Will it affect my day-to-day finances?
Am I putting my family to risk?

Given below is a generic example, which should enable you to work out for yourself, as to what should be your maximum borrowings.

Important: This has nothing to do with how banks calculate your loan eligibility. They would to like lend the maximum amount possible. After all, it's their business and they would like to maximize their interest income. Beware! Their maximum loan eligible amount may be pushing you into the danger zone. So, you should calculate your own SAFE limits.

Weigh your loan options carefully, before you take on the burden of debt.

Suppose, you are planning to buy a new car. The on-road cost of the same is around Rs.6.50 lakhs. 

You have recently received your annual bonus of Rs.1.50 lakhs. You propose to utilize the same as down-payment. And, the balance Rs.5 lakhs would be financed through a car loan.

The terms of the car loan are as under:
Amount : Rs.5 lakhs
Interest Rate : 11.50%
Tenure : 4 years

Now the key question...
... Is it fine to borrow Rs.5 lakhs for the new car?

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

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

You have no other loan liabilities and your monthly take-home salary is around Rs.45,000.

Accordingly, when you avail the above car loan, your Debt-to-Income ratio (DTI) would work out to 29% (= 13,044 / 45,000). In other words, nearly 1/3rd of your salary would go towards financing your car.

Thus, you would be left with only about Rs.32,000 to meet your average monthly living expenses. Further, you have to live with this reduced income for the next four years. You and your family may have to compromise on many desires during these years. 

It is strongly recommended that the borrowing for car (including personal loans and credit card outstanding, if any) should be such that the total EMIs do 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 is not advisable to borrow Rs.5 lakhs.

Of course, you need not give up on the idea of buying the car!

To resolve the problem, you have two options.

Option 1 (Preferable)
The best alternative is to increase the down-payment from Rs.1.50 lakhs to Rs.2.25 lakhs.

This would reduce your monthly EMI to about Rs.11,088. And you will have a more manageable Debt-to-Income ratio of 24.64%.

Option 2
The other option is to increase the loan tenure from 4 to 5 years.

This would reduce your monthly EMI to Rs.10,996 and the Debt-to-Income Ratio to 24.44%.

The question is... why Option 1 is the preferred alternative? 

For this, let us look at how much total money would go out of your pocket, over the loan tenure.

Option 1: Rs.2,25,000 + Rs.11,088*12*4 = Rs.7,57,216
Option 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 quite clearly the recommended option.

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

Concluding: You should be guided by your Debt-to-Income Ratio to decide how much you should borrow. This will keep your loan liabilities within the prudent levels. It will help you to fulfill your desires... without creating much financial stress.

An Investment In Knowledge Pays The Best Interest ~ Benjamin Franklin

101 Classic Tips Money Gyaan

You Learn A Lot By READING... And Even More By SHARING.

Share Button

Ignorance is like a SIGNED BLANK CHEQUE... anyone can MISUSE it.

Subscribe via Email
Powered by Blogger.

... Three VALUABLE Tips ...

1. Why Mutual Funds Won't Survive On The Planet Mars
No Mutual Funds on Mars
Mutual Funds would be a totally ALIEN concept on planet Mars.


2. 10 Key Features of 'Standard Individual Health Insurance'
Standard Individual Health Insurance
Salient aspects of the Arogya Sanjeevani Policy.


3. Refinance Home Loan In Early Years (For Maximum Gains)
Loan Refinancing
Think before you make your move to refinance your loan.