Here is a case study:
Meet Wayne, a 25-year old executive based in Kuala Lumpur. He earns a decent salary of RM 4,000 a month. Presently, he plans to buy himself a nice car, which costs RM 100,000. Wayne intends to place a 10% down payment on the car and finance the remaining 90% with a 9-year, 3%-flat interest rate car loan.
So, how will this car purchase impact Wayne’s financial life?
Let’s assume, typically, Wayne could realistically sell off his car on a car portal in Malaysia at RM 50,000 after driving it for 10 years. This means, the value of car:
At Year 0 = RM 100,000 (Brand New)
At Year 10 = RM 50,000 (Estimated Disposal Price)
This works out to be a CAGR of -6.7% over the next 10 years. It means, the car’s market value is projected to depreciate by 6.7% a year in the 10-year period.
Link: CAGR Calculator
From above, Wayne will borrow RM 90,000 in car loan at a 3% flat interest rate. With a 9-year loan tenure, Wayne shall pay RM 1,058.33 in monthly installment to service his car loan.
Here is a note.
The 3% flat interest rate is not exactly the effective interest rate that he actually incur to purchase his car. This is because the flat interest rate does not take into account the compounding period when Wayne is servicing his car loan. Thus, in Wayne’s case, by converting flat interest rate into effective interest rate, Wayne would realise that he is incurring 5.5% a year in effective interest rate for his car loan of RM 90,000 throughout the 9-year loan period.
So, upon his car purchase, Wayne would incur:
a. Depreciation of 6.7% a year from his car value of RM 100,000.
b. Effective interest rate of 5.5% a year on his car loan of RM 90,000.
#3: Future Loan Eligibility
Let’s say, Wayne does not have any debt commitment prior to his car purchase.
Thus, upon his car purchase, he will have a debt-service ratio of 26.5%, which is calculated as follows:
Debt-Service Ratio (DSR)
= Total Monthly Debt Commitment / Monthly Income x 100%
= RM 1,058.33 / RM 4,000 x 100%
Thus, if banks set credit policies to limit their lending activities at DSR of around 60%, in Wayne’s case, he shall be eligible for a maximum debt commitment of a total of RM 2,400 a month, based on his current income of RM 4,000 a month.
Of which, he had used up RM 1,058.33 to purchase his RM 100,000 car and as a result, leaving him with RM 1,341.67 in future allowable debt commitments for other debts such as another car loan, mortgage, credit card loan, and so on and so forth.
So, let’s say Wayne wishes to acquire himself a piece of property.
Based on RM 1,341.67 in allowable debt commitments and the Rule of 200, the maximum amount of mortgage Wayne could be eligible for is RM 268,334.
Maximum Mortgage Eligibility
= ((Monthly Income x 60%) – Total Monthly Debt Commitments) x 200
= ((RM 4,000 x 60%) – RM 1,058.33) x 200
= (RM 2,400 – RM 1,058.33) x 200
= RM 1,341.67 x 200
= RM 268,334
What if Wayne decides to buy a property first before purchasing a car?
In his case, Wayne would be eligible for a mortgage worth RM 480,000, not just RM 268,334 calculated above. Hence, this shall give him more property options than him, purchasing a car first before buying himself a property.
#4: Additional Expenses
Obviously, unless Wayne is a taxi or a Grab driver, he would most likely not earn recurring income from his car.
But, Wayne shall incur a handful of recurring expenses that will come with a car and they include petrol, parking fees, toll fees, maintenance, car insurance, and road tax. All in all, inclusive of his car loan installments of RM 1,058.33 a month calculated above, it is possible for Wayne to spend about 35%-50% of his salary on car-related expenses on a monthly basis.
If that is his case, Wayne will find it difficult to save money from his current job, making it difficult to move ahead financially.
But I Still Want a Car
The above is written from the perspective of finance.
Hence, it fails to take into consideration other factors of why a person wishes to buy a car. So, here is a question for you if you are looking to buy a car today:
‘Are you really buying a car as a means of transportation?’
‘Or, are you actually buying ‘something’ that comes only from owning that car?’
So, what is that ‘something’ that you desire for?
Is it respect?
Is it acknowledgement?
Is it to gain attention and attraction?
Is it love and affection?
Or, is it something else?
Is it wrong to pursue the above?
Nope. This is because all of us do have a desire for all of the above. But, the key question is, ‘Is it worth pursuing the above by getting a loan to buy a car?’
Now, that would be a food for thought.
But I Need a Car for Work
Let’s say a car is a necessity for Wayne as he needs to drive during work.
So, the question is, ‘What is the maximum car price that he could afford?’
I learnt this from KC Lau in his webinar presentation on car financing.
Of which, KC suggested that the maximum car price one could afford financially is 4 times his monthly income. Thus, in Wayne’s case, he should not be buying a car costing RM 100,000. Instead, the maximum price he can pay for a car would be RM 16,000, which is 4 times his monthly income of RM 4,000.
Initially, when I heard of this from KC, I was stunned.
I thought to myself, ‘What kind of car would that be?’
But, to my surprise, a quick search at Carlist.my has really enlightened me to an ocean of choices of cars that we all could buy at a price below RM 20,000. So, if you think it is not possible initially, it actually is quite plausible.
Of course, the question is, ‘Is it desirable to you or not?’
But, with that being said, if you need a car as it is a necessity and you truly have a desire to improve your financial life, it would be helpful to you if you give KC’s suggestion a consideration. In fact, you may view KC Lau’s webinar recording on car purchasing and financing at the following link:
Webinar: Car Purchase & Financing