Buying a new car: Should you use up your savings or opt for a loan?

New Delhi: Car sales are expected to cross the 10 lakh mark in the upcoming festive period due to pent up demand,  especially for utility vehicles. The 68-day festive period this year falls between August 17 and November 14. 

While purchasing a car there are two options available for the owner, whether to go for a car loan or pay ouright cash. While financing might make purchasing a vehicle more reasonable, spending outright cash can get you a better price and eliminate the need for annual payments. 

If you don’t want to delay your car purchase but don’t have the  money you need for it, then you will need a car loan. But what if you have enough savings? What should you do then? 

If you are invested for the long term, breaking your investments for a car doesn't make sense

"Ideally, it is dependent on an individual’s finances, however in today’s scenario even if someone has surplus money, it is largely invested in equity markets via shares or mutual funds. If the original goal of that investment is for the long term and not for the car, then breaking them would not be recommended. However, if you have invested money to buy the car then it is better to use that to fulfil the goal," said Krishna Kanhaiya, CEO of Mirae Asset Financial Services .

While calculating your savings, don't take into account savings kept aside for emergencies
Today car loans are available at relatively cheaper interest rate compared to personal loans and there are many pocket friendly cars available in the market. While calculating savings one must not count savings which are kept away for emergencies. 
 

"The total cost of loan should include processing, documentation costs, Mortgage cost and others. Usually if you take a car loan the cost of car increases by almost 20% to 30% depending on the tenure of the loan. Currently Interest rate charged by the banks are around 8.5% to 9%. One has to compare this cost to the interest benefit on savings [net of tax] while deciding if a car loan is better or one should directly go for buying a car from savings," said Anshu Agarwal, Global Head of Finance at Branch International.
 

A car loan is available based on the income generated so it might be difficult for many people to go for a car loan and wait till they generate enough savings to buy a car.

Usually, banks provide loans to salaried class much faster compared to individuals whose source of income is business.

If you have a good credit score, you may be able to get a lower interest rate on a car loan

 This could save you money in the long run. "Make sure that you can afford the monthly payments on a car loan as you don’t want to end up in debt. Car insurance is mandatory in India. The cost of car insurance will vary depending on the car you buy, how old the car is and the total claims taken on the car. Cars require regular maintenance and repairs so you need to factor in this cost as well," said Adhil Shetty, CEO of Bankbazaar.com.

There are other costs like document charges, processing fees, and GST on that processing fees. To give you a sense of how much you will pay, here is the list of Car Loan Interest Rates and Processing Fees of some leading banks in India, provided by Paisabazaar.



 

Whether to buy a car with a loan or with savings depends on your finances. Weigh the pros and cons of each option and choose the one that is best for you.
 

Example:

The table provided by Bankbazaar below compares the total savings you will have when you purchase a car loan with and without a loan. You can see the loan amount of Rs10 Lakh with interest rate of 9 per cent becomes more than Rs 13 lakh and your total car loan cost goes above Rs 18 lakh. On the other hand, when you buy using your savings, you save a significant amount by paying zero interest on your purchase. 

Majority banks  give you 80% to 90% of the car’s on-road price as a loan, which means you still have to pay 10% to 20% as downpayment at the time of purchasing the car. So if you take a loan for a car with an on-road price of Rs 12 lakh, you will have to make a down payment of Rs 1.2 lakh to Rs 2.4 lakh. Taking a car loan will give you instant access to the car but you end up paying 20% to 30% extra on the on-road price and you won't own the car until you pay off the entire loan. In contrast, by using your savings to buy the car, you immediately own the car and are debt free.

"If you want to refinance to reduce EMIs, evaluate the remaining tenure of your existing loan. Extending the loan tenure may lower your monthly payments but could increase the total interest paid over time. Reducing the loan tenure can help you pay off the loan faster but may increase monthly payments," said Shetty.

If you already have a car loan and want to reduce overall interest, compare different lenders to find better interest rates.

Lower interest rates can help you save money in the long run. Negotiate with the lender to get better terms and possibly reduce or waive processing fees. Some lenders may offer promotional offers or discounts to attract refinancing customers. A good credit score can help you negotiate better loan terms and interest rates. 

Refinancing a car loan is another option:

"Based on the macroeconomic situation and the credit history of the customers many individuals who were earlier not given a car loan are now eligible for the car loan.

"Whether one should go for a car loan or not actually depends on whether you have enough savings or not and whether the cost of borrowing is higher or lower than the savings. It also depends on if you have enough savings in the first place.  One advantage of taking a car loan is that if you prepay on time it helps in improving your credit score," said Agarwal.

Another option is to avail a loan against mutual funds and shares

If you have invested for a long-term goal and you need to generate liquidity for the short term, then you can pledge them and avail loan against mutual funds and shares

"Such options give users more flexibility of prepayment, foreclosure, speed, convenience, and interest rate is comparable to car loan. Also, you save the hassle of RC hypothecation and other documentation-related hassles during loan closure," said Kanhaiya. 

Let’s understand with an example. Mr X needs a loan of Rs 15 lakh considering the best-case interest rate of 8.5% p.a. to finance the car and has decided on a loan tenure of 3 years. Instead of availing a car loan Mr X has availed a loan against his mutual funds (at 9% p.a.) of the same amount (Rs 15 lakh). He decided to repay Rs 35,000 per month for year 1, Rs 40,000 per month for year 2 and Rs 45,000 per month for year 3. Also, he can make yearly two big payments of Rs 1.5 lakh in January year 2 & January year 3. Below is the summary of the calculation between a car loan versus a loan against securities.

Loan Against Mutual Funds

- With loan against mutual funds total interest paid due to early repayment of the principal amount, is less compared to a car loan.

The processing fee of a fixed Rs 999 + tax is also less than a car loan.

Considering the above example, you save approx Rs 14,000 on the interest & other charges. - Apart from this, you get flexibility for monthly repayments, you can repay more or less based on your convenience and the entire amount gets adjusted with the principal amount without any prepayment charges.

If you get a lumpsum amount from somewhere and pay that to the loan against mutual funds account, interest would reduce considerably.

Hence, this can be a good way to access cash without having to sell your investments, which can help you avoid capital gains taxes and keep your investments growing.