Last few days I was searching for options to buy a car. I was ready to pay the total cost from my savings. Just today i had a discussion with Nilesh (my reporting manager) about this decision. I generally discuss the financial decisions with him. He gave me an interesting calculation which stun me. There were 2 options
Option 1: Pay 10 Lakhs as a down payment and purchase the car.
Option 2: Put 10 Lakhs in FD and take a car loan for 10 Lakhs
Here assumptions are you have Rs. 10 Lakh and you also have capability to pay EMI. Both the things are achievable only then below options are viable.
Option 1 is straight forward. You have money and your paid it
Option 2 I take a loan of 10 Lakh Rupees for 5 years @ 9.8% interest per year, then EMI I need to pay will be Rs. 20,977. In total 60 installments I will be paying. As car loans do not have pre-payment option I am bound to pay 20977 * 60 = Rs. 12,58,620. Simultaneously I put the amount which i have in my saving i.e. 10 Lakh in fixed deposit (the 2nd worst investment option, first is keeping money in saving account) @ 7.25% per year. Then due to compounding interest calculation I will get 1000000 * (1.0725)^5 = Rs. 14,19,013. This figure is more than what I will be paying over 60 months. Moreover I have the amount at my disposal. I can take out the money from FD and use it. At end of 5 year I will be saving Rs. 1,60,393 in option 2. isn't this amazing?
Then Lalit (friend sitting on next seat) jumped in the discussion. He said that in the above calculation we are not taking EMI amount in calculation. It was a valid point. If I pay all amount at once then I have EMI amount which should be invested. So we choose an option of creating Recurring Deposit (yet another worst option of investment better than FD) so 7.25% for 5 years with RD amount 20977 will give the Rs. 15,18,953. This created 3rd option.
Option 3: Pay 10 Lakhs and create RD of 20977 for 5 years. This will give Rs. 15,18,953 at end of 5 years.
Looking at the comparison it is clear to opt for option 3 of paying 10 Lakhs and buy a car. The catch here is one must create RD else the benefit is lost. If want to earn more profit, go for better investment options like mutual funds, corporate FDs, blue chip shares, etc..
To summarize it below are the options and benefits
Option 1: Pay 10 Lakhs as a down payment and purchase the car.
Option 1: Pay 10 Lakhs as a down payment and purchase the car.
Option 2: Put 10 Lakhs in FD and take a car loan for 10 Lakhs
Here assumptions are you have Rs. 10 Lakh and you also have capability to pay EMI. Both the things are achievable only then below options are viable.
Option 1 is straight forward. You have money and your paid it
Option 2 I take a loan of 10 Lakh Rupees for 5 years @ 9.8% interest per year, then EMI I need to pay will be Rs. 20,977. In total 60 installments I will be paying. As car loans do not have pre-payment option I am bound to pay 20977 * 60 = Rs. 12,58,620. Simultaneously I put the amount which i have in my saving i.e. 10 Lakh in fixed deposit (the 2nd worst investment option, first is keeping money in saving account) @ 7.25% per year. Then due to compounding interest calculation I will get 1000000 * (1.0725)^5 = Rs. 14,19,013. This figure is more than what I will be paying over 60 months. Moreover I have the amount at my disposal. I can take out the money from FD and use it. At end of 5 year I will be saving Rs. 1,60,393 in option 2. isn't this amazing?
Then Lalit (friend sitting on next seat) jumped in the discussion. He said that in the above calculation we are not taking EMI amount in calculation. It was a valid point. If I pay all amount at once then I have EMI amount which should be invested. So we choose an option of creating Recurring Deposit (yet another worst option of investment better than FD) so 7.25% for 5 years with RD amount 20977 will give the Rs. 15,18,953. This created 3rd option.
Option 3: Pay 10 Lakhs and create RD of 20977 for 5 years. This will give Rs. 15,18,953 at end of 5 years.
Looking at the comparison it is clear to opt for option 3 of paying 10 Lakhs and buy a car. The catch here is one must create RD else the benefit is lost. If want to earn more profit, go for better investment options like mutual funds, corporate FDs, blue chip shares, etc..
To summarize it below are the options and benefits
Option 1: Pay 10 Lakhs as a down payment and purchase the car.
Option 2: Keep 10 Lakhs in FD which will give you Rs. 14,19,013 and take a loan of 5 Years & pay Rs. 12,58,620. Effectively at end of 5th year you will have Rs, 1,60,393.
Option 3: Pay 10 Lakhs and create RD of 20977 for 5 years. This will give Rs. 15,18,953 at end of 5 years. Effectively you will have Rs. 5,18,953.
Moral of the story, best is option 3, but if you don't invest EMI amount then option 2 is better.
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