Should you take a loan to buy a big car?

Ashwin is a 30-year-old tech professional, working for the past five years. He earns well and spends much on luxuries. His lifestyle does not allow him to save much . Recently, he decided to buy his first car and shortlisted a model.

However, lured by the easy EMI repayment options, he is tempted to buy a bigger car. Going for the bigger car would also mean a higher down payment. Ashwin is not too worried about it as he already has the money required. Is Ashwin making a decision after considering all the aspects of his finances?

Ashwin is planning a large investment in an asset that depreciates the moment it is driven out of the showroom. He is tying himself to a higher obligation and for a longer period which may seem affordable now, but may change once he has bigger commitments. He needs to evaluate if he is comfortable with these decisions.

The money that he is planning to use for making the higher down payment, can be invested, and so can be the additional amount he will pay as EMI for the bigger car. This is likely to build him a neat corpus over the same period instead of seeing the money lose value. Buying a larger car would imply a longer loan tenor. In the initial years, a larger portion of the EMI would go towards paying interest rather than principal. If Ashwin decided to sell the car after a few years, he would probably find that the value is not even sufficient to pay off the outstanding loan.
Ashwin needs to find a middle ground that will help him cater to his desire for expensive things and at the same time not compromise his future financial position. One way would be for him to buy the car that he had originally intended to, on a loan with a short tenor. Since he has a good income with no commitments, he should be able to pay a higher EMI and pay-off the loan fast.

In a few years, when he has the need for a larger car and has a higher income, he can sell this car which is free of encumbrance and use the amount as the down payment for the new one. His financial situation is also likely to be stronger by then. He would have to postpone fulfilling his desire for a few years. But this will help him create an investment portfolio that would hold him in good stead in the long run.

(Content on this page is courtesy Centre for Investment Education and Learning (CIEL). Contributions by Girija Gadre, Arti Bhargava and Labdhi Mehta.)