Imagine you are a 25-year-old executive based in Kuala Lumpur earning a decent salary of RM4,000 a month. You have had your eye on a car that costs RM100,000, and you finally decide to buy it.
You intend to place a 10% down payment and finance the remainder with a nine-year, 3% flat-interest-rate car loan.
Here are four ways this purchase would impact your financial life.
1. Future market value
Cars notoriously depreciate in value over time, especially if they are driven on a day-to-day basis. If you were to sell your car after 10 years for RM50,000, it would have depreciated by 50% and would have a compound annual growth rate of -6.7% over the 10-year period.
2. Liability
If you were to borrow RM90,000 with a 3% flat interest rate, you would pay RM1,058.33 monthly to service the loan.
Bear in mind, though, that the interest rate does not take into account the compounding period in which the loan is serviced. By converting the flat interest rate into an effective interest rate, you would be incurring 5.5% a year for the loan throughout the repayment period.
3. Future loan eligibility
Upon your car purchase, assuming you do not have any previous debt commitment, you would now have a debt-service ratio (DSR) of 26.5%, calculated as follows:
- Debt-service ratio
Total monthly debt commitment / monthly income x 100%
= RM 1,058.33 / RM 4,000 x 100%
= 26.5%
If banks limited their lending at a DSR of around 60%, you would be eligible for a maximum debt commitment of RM2,400 a month, based on your current income of RM4,000.
From this, you would be left with RM1,341.67 in future allowable debt commitment for mortgages, credit card loans and so on, since RM1,058.33 goes to your car loan.
If you were to decide to buy property, taking into account the RM1,341.67 in allowable debt commitment and the Rule of 200, the maximum amount of mortgage you would be eligible for is RM268,334:
- Maximum mortgage eligibility
= ([Monthly income x 60%] – Total monthly debt commitments) x 200
= ([RM4,000 x 60%] – RM 1,058.33) x 200
= (RM2,400 – RM1,058.33) x 200
= RM1,341.67 x 200
= RM268,334
But if you had decided to buy property prior to buying the car, you would have been eligible for a mortgage worth RM480,000, thus allowing you more property options.
4. Other expenses
Unless you become a delivery or rideshare driver, you would not likely earn any recurring income from the car. You would, however, have recurring expenses in the form of petrol, parking fees, toll payments, maintenance, car insurance and road tax.
Coupled with the loan amount of RM1058.33, you would end up spending up to 50% of your salary on car-related expenses a month, making it difficult for you to save money or move ahead financially.
So when you have your heart set on a new car, it is important to ask yourself: “Do I really need it, or do I just want it?”
This article first appeared in KCLau.com.
Ian Tai is a financial content writer, dividend investor, and author of over 450 articles on finance featured in KCLau.com in Malaysia, and ‘Fifth Person’, ‘Value Invest Asia’ and ‘Small Cap Asia’ in Singapore. He is a regular host and presenter of a weekly financial webinar in KCLau.com.