I have some clients, who asked me, “Financial Consultant, Helmi Hakim….I want to buy a car. Should I pay it in full OR take a car loan?”
Well…If you have been reading my blog, for the past few years, you know, that I have been advocating that buying a car, can be both an asset or a liability.It depends on your situation. You can read more here.
But, now, let us focus on the question. The question is, “Should you pay your car in full OR take a car loan?”
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My answer: It depends.
To know, whether you should pay your car in full or take a loan, you will need to calculate the “effective interest rate” of your car loan.
“If you can invest your money, and get higher returns than the effective interest rate of your car loan, you should invest your cash and take a car loan.
If the effective interest rate of your car loan is higher than your investment return, you should use your cash to pay off the car ASAP.”
I will give an example to illustrate my point.
Car HP (Hire Purchase)
Price: $65,000
Less Deposit 15,000
HP Principal 50,000
Example, the car, that you will like to buy costs $65,000. You pay a deposit, of $15,000. So, you will be left with an outstanding hire purchase principal of $50,000.
If your car loan interest is 5% “Flat” for 5 years,
Add Hire Purchase Interest
$50,000 X 5% X 5 = $12,500
Total Amount Payable Including Interest = $62,500
Monthly Instalments= $62,500/ (5 years X 12 months) = $1041.67 per month
You need to pay a monthly instalment of $1041.67 for 5 years.
So, how do we calculate the “effective interest rate” of your car loan from here?
Take Out A Financial Calculator.
Key in this input. Solve for i (interest).
PMT = -1041.67
PV= +50,000
n= 12 X 5
i = ???
Solve for i and you will get 0.762817% interest per month. Multiply it by 12 months, and you will get the effective interest rate of your car loan, which is 9.15% per annum.
It means, if you have $50,000 cash right now, and your investment skills allow you to generate investment returns of more than 9.15% per annum, then you should not pay your car in full.
However, if you cannot get such a spectacular return, it is best, that you pay off your car loan as soon as possible. Hope my sharing helps! Click share if you find it useful! 🙂
p.s. By the way, if you wish to discover a simple & halal way to create a positive monthly cashflow and calculate your net worth for FREE, then please click here…
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