One of the most common aspirations among youth, no sooner they get a job is either to buy a house or a vehicle. Call it a necessity or a hidden desire, but the urge to own an asset is very high as soon as one gets a job and there is some extra money left-over after meeting the expenses.
Generally the order of preference is to buy a house first and then a car. Financially speaking this makes a lot of sense as a house is an appreciating asset while a car is a depreciating asset. The moment a car is bought its value comes down. Over the years as it is used the value keeps on falling. On the other hand real estate prices generally tend to move higher. Though there are periods when they have fallen or not moved at all, the trend normally is a slow gradient higher in the case of real estates.
After a house is bought and there is still money left post expenses in monthly salary, the next thing on the buying list is a car.
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An asset for an employer but a liability for an employee
But buying a car is not as easy as it seems. Selection of car is perhaps the easier part. Most people buy a car if they like the model, a price point and the brand name. Little attention is paid to the financials engineering required in buying a car.
As mentioned earlier, a car is a depreciating asset. Thus the moment it is registered in your name it loses value even if you want to sell it the next day. However, a person can take advantage of the loss due to drop in value. But the catch here is the income profile of the individual.
For those involved in businesses buying a vehicle in the company’s name is advantageous as the asset is added to the balance sheet of the company at the same time they can claim depreciation benefit and lower their tax outgo.
These days many companies offer a choice of remuneration to be taken either in the form salary or consulting income. Those who get their pay packet as consulting income have the same advantage as the business man. They can claim benefit of the depreciation of the car and get a lower tax liability.
At the same time when they sell their car they can book either a profit or loss on the sale – which is calculated by deducting the depreciations claimed.
Let’s consider an example. Say a car costs Rs 10 lakh and assume that the car is depreciated at a flat rate of 20 percent. This means the individual can get benefits to the extent of Rs 2 lakh a year before his taxable income is calculated.
Now suppose the individual wants to sell the car after using it for four years at a price of Rs 5 lakh. After four years he has already claimed depreciation benefit of Rs 8 lakh and thus the residual value of the car is now Rs 2 lakh. But as the individual is selling the car for Rs 5 lakh and has claimed excess depreciation he is sitting on a profit of Rs 3 lakh. This is because the car is worth Rs 2 lakh in the books of account of the individual and he is selling it for Rs 5 lakh. This is also one of the reasons that businesses and people with good financial acumen prefer a car with a good resale value.
If in case the selling price is lower than the book value of the car the individual can claim a loss and get tax exemption to that amount. This is the big advantage of buying a car when receiving your salary as a consultant. You get to enjoy the car at the same time save your taxes and if you are lucky earn a profit in the end.
Saving to buy a car
Unfortunately the salaried employee gets no fiscal benefit for buying a car. He in fact has to plan his finances well to afford a car. However, it is the financial planning that makes owning a car a pleasant experience or a soar one. Many people sell their cars after owning it for a few years because they cannot afford it.
Thus the financial aspect of buying a car should also be given equal weightage if not more in choosing a car.
Let’s take an example where a person earns Rs 90,000 a month and is keen on buying a car. The first thing to calculate is the spare cash he has. Assume his monthly expenses are Rs 30,000 and house loan takes another Rs 30,000 every month. This leaves Rs 30,000 which the person thinks he can use to pay the car loan.
Ideally the money should have been put to better use by investing. As the renowned investor Warren Buffett says first save and then spend. Out of the Rs 30,000 it would be better if the individual saves Rs 20,000 and makes Rs 10,000 available for the car’s monthly instalment.
His choice of car should be one which requires a monthly payment of Rs 10,000. There is however, a small question of margin money. Car finance companies and banks do not finance the entire value of the car. Depending on the bank, finance companies and client’s relation with theman individual can get between 85 to 90 percent.
Now the person has to work around two numbers. First is the monthly installment of a maximum of Rs 10,000 and second is the margin money of say 15 percent. At a rate of 10 percent per annum, an EMI of Rs 10,000 per month is available for a loan of Rs 475,000. This corresponds to 85 percent of loan amount. Thus the individual will have to look for a car which will be around Rs 550,000.
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A bigger car would not only mean higher monthly installments but also higher margin money and in many cases higher operation and maintenance cost. This ultimately results in tighter budgets going forward and results in the person selling his car.
In the above example if the car buyer is willing to wait for a few years he could invest his spare Rs 30,000 per month in equity markets which generally gives a return of over 16 percent. Even if it gives a return of 15 percent the buyer can finance his car purchase from the capital appreciation after the second year, provided he continues to invest Rs 30,000 every month.
Buying an asset is the easier part, but making your saving work for you and finance the purchase is where the fun is.