If you have the money for a car, should you pay cash or take a loan and keep your savings invested? The answer comes down to one comparison: does your money earn more, after tax, than the loan really costs?
The loan’s true cost
The quoted rate is not the whole cost. A processing fee means you receive less than you borrow, but still repay the full amount. Take an ₹8 lakh loan at 9% over 5 years with a ₹5,000 fee:
- EMI ₹16,607, and ₹1.96 lakh of interest over the 5 years.
- Counting the fee, the loan really costs 9.67% a year. That is the return your savings need to beat.
Cash or loan, worked through
A ₹10 lakh car. One buyer pays cash. The other pays 20% down and the fee, takes the ₹8 lakh loan above, and keeps the rest invested. To keep it fair, the cash buyer invests every month the EMI the other buyer pays. Savings earn an illustrative 7% a year after tax.
After 5 years, both own the same car and owe nothing. Paying cash comes out ₹67,298 ahead. If savings earned 10% a year after tax instead, the loan would come out ₹8,927 ahead. The switch happens at 9.67%.
- Pay cash, invest the EMI each month₹11.82 lakh
- Take the loan, keep the savings invested₹11.15 lakh
₹10 lakh car; loan of ₹8 lakh at 9% for 5 years with a ₹5,000 fee; savings earn 7% a year after tax.
| Your savings earn after tax | Comes out ahead | By |
|---|---|---|
| 6% | Cash | ₹90,039 |
| 7% | Cash | ₹67,298 |
| 8% | Cash | ₹43,253 |
| 9% | Cash | ₹17,859 |
| 10% | Loan | ₹8,927 |
| 11% | Loan | ₹37,151 |
Same car and loan as above. The switch is at 9.67%.
Watch for flat rates
Some car loans are quoted at a flat rate, which is worked out on the full amount for the whole term, even though you repay it month by month. It sounds much cheaper than it is.
A “flat 5%” on ₹8 lakh over 5 years means ₹2 lakh of interest (5% × ₹8 lakh × 5 years) and an EMI of ₹16,667. That is about the same as a 9.15% loan on the usual reducing balance. So always ask for the reducing-balance rate, and compare that.
| Quoted flat rate | EMI on ₹8 lakh, 5 years | Real rate a year |
|---|---|---|
| 4% flat | ₹16,000 | 7.42% |
| 5% flat | ₹16,667 | 9.15% |
| 6% flat | ₹17,333 | 10.85% |
| 7% flat | ₹18,000 | 12.5% |
The real rate is the reducing-balance rate that gives the same EMI.
Try it
What a flat rate really costs
- EMI
- ₹16,667
- Total interest
- ₹2.00 lakh
- Real rate a year
- 9.15%
A 5% flat rate costs the same as a 9.15% loan on the reducing balance.
Beyond the numbers
- Keep an emergency fund. Paying cash is not worth it if it empties your safety net.
- Will you really keep the savings invested? The loan only wins if the money stays invested for the whole loan.
- Offers. Dealers sometimes give discounts only on loans, or only on cash; count them in.
- The car is pledged to the lender until the loan is repaid.
Try your own price, rate, fee and return in the cash or car loan calculator.
For education only. Not investment, tax or insurance advice. Examples use the figures stated in the guide; check your own before you act.