Should you take a loan for consumer durables?
The festival season brings several offers of ‘zero interest’ loans from sellers of consumer durables. They expect that the facility of repayment in instalments will make the buyers want to purchase more. How does one evaluate financing the purchase of large-ticket items?
First, purchasing a durable, including a vehicle, is for the purpose of consumption. None of these consumer durables is an asset and all of these depreciate in value soon as they have been bought. The logical way to look at this expense is to ask yourself the period for which it is going to be used and how the expense pans out. Assume that a car bought for Rs 5 lakh is expected to be used for three years, after which it fetches a resale price of Rs 1 lakh. You are effectively expending approximately Rs 11,000 per month on the car.
The decision you need to make is whether you think this amount is worth spending for the comfort you desire and if your income permits this kind of allocation. The same is true for your television, fridge and air conditioners. They are all expensed over a fixed lifetime, have a limited resale value and should be seen as an aggregated upfront expense. You can bring some discipline in your decisions to replace white goods too often if you make up your mind upfront about how long you intend to use it. If you fancy changing your gadgets too often, it implies a higher level of monthly charge. You need to be sure that your income supports this fad and you are fine with the resultant lower level of saving.
Second, should a consumption expense be funded by a loan? Every loan comes with an interest cost and will reduce the surplus available for saving. However, a loan is necessitated whenever the expense is too large to fit into regular income. Paying for a durable over a period of time is more convenient, which is the reason that buying on instalments is popular with most. Thus, more than the loan itself, the cost of the loan is an important factor. A zero interest loan is a clever package.
The seller usually takes an administrative fee upfront and asks for a few instalments to be paid in advance. This means the effective loan amount is lower and the fee collected is actually the interest on the balance amount to be paid in instalments. Before considering the consumer loan at the shop, look at other options. Would you be able to get a loan against your bank deposit at a lower rate? Can you get a personal loan at a lower rate? Buying a durable with a credit card and paying the balance over time is the most expensive option. If there are other low-cost options, go for them.
Third, consider the opportunity cost of money. If you have adequate money to pay upfront for the durable, should you consider taking a loan? You could do so if you are able to deploy the money in an investment option, which offers a higher return than the cost of the loan given by the seller. It is usually difficult to find safe investment avenues that offer returns higher than those of a consumer loan.
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