Congratulations on your decision to purchase a new car! You have taken the first important step by setting a budget. If you have not yet determined your budget for your car refer to our blog on points to consider while setting a budget for your car. Once you have set the budget, the next step would be to focus on how you will pay for the car. You could either finance the car from your savings or avail a car loan. If you have saved enough money to buy the car through disciplined saving, you should be proud of yourself for prioritising long-term goals and making a smart financial decision by delaying immediate gratification. However it is not possible for everyone to save the full amount required to purchase the car and therefore it is necessary for the majority of people to avail a car loan. Having decided to take a car loan, the bank would require you to make a down payment towards the car. The amount of down payment required to be contributed will depend on various factors like :
The Cost of your Car: As a general rule, the more expensive the car, the more money, as a percentage of the cost of your car, you will have to put down as down payment
Your Credit Score: If you have a good credit score, you may be required to put down a smaller down payment. On the other hand, if you have a lower credit score, you may be required to put down a larger down payment to offset the risk to the lender.
Terms of the lender: Some lenders require you to put down a higher amount of down payment to secure themselves against potential default risk. They want you to have ‘skin in the game’.
We would suggest you make a down payment of at least 20-25% of the price of your car. This will help secure favourable loan terms and reduce the overall cost of borrowing by demonstrating to the lender that you are committed to repaying the loan and owning the car. The second benefit would be that you practise delaying gratification which is an important virtue to master for everyone on the road to financial independence. More on delayed gratification in our separate dedicated article.
Assuming you are convinced and ready to pay 25% of the cost of your car (Rs 15 lakh) as a down payment, you would have to save Rs 3.75 lakh. If you wish to save this amount over the period of 2 years you would have to save 15,625 per month.
Further, you can start a SIP in a short-term debt fund of Rs. 15,625 every month, assuming a XIRR of 6% by the end of 2 years the value of your contribution would have increased to almost Rs. 4 lakh. This increase in the value of your savings would sponsor the increase in the cost of the car over the two-year period (effect of inflation). You can also invest in an equity fund or hybrid fund to generate higher returns over your savings, but the risks would also be higher. Equity investments should be preferred if your goal is at least 5 years away. In the short term, the fluctuation in equity investments could be higher and therefore we suggest investing your money in a debt fund.
To conclude, it would be wise to start saving early and pay at least 20% of the cost of the car as a down payment, this will reduce the interest burden to a certain extent as well as help in getting a loan at lower interest rates from the bank.
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