Two easy ways to decide on a budget for a new car

NEW DELHI: Car loans have made it expensive cars affordable. Auto loans increase affordability, but it’s always better to arrive at a budget based on income and liabilities.

For most, purchasing a car is the second biggest buying decision after a home. However, it’s a depreciating asset so it is prudent to spend what you can easily afford.

Here are some ways for you to decide on the affordability.

DECIDING THE BUDGET

Two rules that can help you to arrive at a budget. First, don’t spend more than half of your annual income on a car. Suppose your annual income is Rs10 lakh. Your budget for the vehicle should be around ₹5 lakh.

Don’t worry about whether you should consider net income or gross income. It’s entirely up to you. However, decide the budget based on the on-road price of the car – not the showroom price.

The other rule helps you decide the budget if you are taking a loan to purchase the car. According to the 20/4/10 rule of thumb, you should be able to pay 20% of the on-road price as the down payment. The loan tenure should be for a maximum of four years, and the equated monthly instalment (EMI) should not be more than 10% of the monthly income.

To understand the rules better, let’s look at some examples. Suppose your annual income is Rs12 lakh, your vehicle cost should be below Rs6 lakh.

Based on the second rule, you should offer Rs1.2 lakh as a down payment, and the EMI should be around Rs10,000. In this case, you will need to take a loan of ₹4.8 lakh for four years. At present, most lenders are offering car loan starting at 7.5-8%.

If you take a ₹4.8 lakh loan for four years at an 8% interest rate, the EMI will be ₹11,718.

Will it be prudent to pay higher EMI than what the rule of thumb suggests? Thumb rules are guiding principles - not carved in stone. It’s up to you to decide what works best for you.

HOW TO STICK TO THE BUDGET

You have several options to stick to the budget. Maybe, you get a bonus that can take care of the slightly higher EMI.

Going by the same example, you can also opt for a cheaper model. Instead of buying a car that costs Rs6 lakh, you can choose a car that costs ₹5 lakh. The 20% down payment will be ₹1 lakh, and the EMI for a ₹4 lakh loan will be ₹9,765.

Another option is to increase the down payment. Instead of paying 20%, you can pay one-third of the cost as a down payment – pay Rs2 lakh instead of ₹1.2 lakh.

Depending on your preference, you can also buy a used car instead of a new one.

The idea is to spend based on your affordability rather than stretching the budget only because a loan is available.

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