Do you really need to own a car today? You might think I’m crazy to even ask this question. For most people, the answer to this question is YES! But before we discuss this topic further, here are some points that you need to consider:
Cost of ownership
Some may think that the purchase price of a vehicle is the cost of ownership. In fact, when you factor in other costs such as financing, maintenance fees, insurance, road tax, etc., the cost of ownership is in fact more than just the purchase price of the vehicle. All these costs differ depending on the vehicle, but often, these ancillary costs go in tandem with the purchase price – the higher the purchase price, the higher the other costs.
Utility value of a car
Usually, people purchase a car as a mode of transportation. However, you have more options these days, which means a car may not be as useful as before. These days, rail transportation is extensively accessible, particularly in the Klang Valley and encompasses the services of Keretapi Tanah Melayu (KTM), Light Rail Transit (LRT) and Mass Rapid Transit (MRT). Not only do these public transportation options cost less, utilising public transport also means less hassle as there’s no need to be focused on driving or other common modern-day problems like traffic jams.
In addition, there are ride-sharing platforms such as Grab if you prefer less crowded transportation. So with all these developments, one should really consider the utility value of a car before pulling the trigger to purchase one.
The value of a car will drop over a period of time. Depreciation starts the moment the car is delivered to you and the rate of depreciation can vary for different vehicles. On average, a vehicle tends to lose 10% to 20% of its value annually, and as such, it’s not surprising that cars are often referred to as a depreciating asset!
Generally, a credit score indicates a consumer’s credit worthiness. Before qualifying for financing, creditors (lenders) such as banks will evaluate our credit score. Usually, a higher credit score represents a better credit standing and lenders will be more confident that you’re able to repay future debts as agreed – making you more creditworthy.
In addition to this, having a higher credit score might also allow us to enjoy a better financing rate, resulting in a lower amount of interest to be repaid, which means you can save more. The opposite is usually true for those with lower credit scores. But here’s a tip to have a better credit score – repay all your loans in a timely manner. Doing this allows you to get a better credit score than people who don’t have any loans.
Debt Service Ratio (DSR)
This ratio represents how much of our income is needed to service the debts you have, and it’s commonly calculated in monthly terms. Some of the regular debt payments include home loans, property investment loans, personal loans, study loans and car loans. A conservative benchmark for this ratio is around 30%, therefore it’s important to be mindful of your DSR before applying for a loan. Those with DSR of more than 30% should be more cautious on their spending especially, when it comes to applying for new loans.
Rule of 78
The Rule of 78 is usually applied to car loans and is a method of calculating interest where a higher percentage of interest charged is paid at the earlier part of the loan tenure. As such, any early settlement of the loan will not help the consumer save much. This is different from the reducing balance method (usually applied to mortgages) where interest expense is based on the outstanding loan amount.
In short, this form of loan calculation does not favour the consumer but rather the banks. Based on the current Overnight Policy Rate (OPR), the interest rate for a car loan is around 3 to 3.4% per annum for a person with an average credit score. Therefore, consumers need to be aware of this before borrowing.
Net worth and cash flow
Once you acquire a car loan, not only is your cash flow affected by the monthly repayment of the car loan, but you’ll also be affected by other expenses such as petrol, car insurance and toll charges. With higher expenses, cash flow could be tighter which may result in less savings available to be channelled to grow our wealth.
Your net worth will also be reduced once you acquire a loan. Why is this important? Since net worth tells you how much your assets are worth after deducting liabilities, if your net worth is positive, it means that you can pay off all debts that you carry after liquidating all assets. However, this isn’t good news for those with a negative net worth position.
Should you buy a car?
After taking all these factors into consideration, you’re now in a better position to weigh the pros and cons of buying a vehicle rationally. Ask yourself – are you willing to sacrifice all the above considerations just to get a depreciating asset? If you are unsure or unconvinced, then maybe taking a Grab is a better option as you won’t have to worry about the costs and monthly repayments, which could have a detrimental effect on our financial well-being in the long run.
Nevertheless, buying a car does have its upside. Some of the benefits include convenience, personal safety and privacy. In the age of Covid 19 – this is also a definite plus! So, buying a car may not necessarily be bad. Alternatively, you may consider getting a second-hand car instead, although this too comes with various costs considerations such as maintenance and repairs. Consumers just have to be aware of all the factors and spend within your means so that you can optimise your money!
About the author
Wong Chee Yang is a licensed financial planner and is dedicated to promoting financial literacy amongst fellow Malaysians. He can be contacted at firstname.lastname@example.org