Sunday, May 1, 2011

0% Financing or Cash-Back Rebate? Neither

If a manufacturer is offering a rebate, should you take that, or 0% financing?  The best answer is usually neither.

I ran into a fellow the other day, and he was using some specious logic (that's the bad kind) to self-justify a poor financial decision.

He bought a $30,000 big crew-cab pickup truck and got the 0% financing deal, instead of the rebate.  His logic was that, if you figure out what the interest is on the loan and what you could earn in the market, you come out ahead paying more in terms of price, with 0% interest.  And it sounds a lot like something his salesman told him.

But of course, astute readers who believe in TANSTAAFL realize that the loan interest is folded into the price of the truck - the discount you don't get from the "list price" (the no one ever pays).  No one is loaning money interest-free, they are just jerking around with the numbers, and when you do that, it skews the pricing.

Why would they do that?  Well, it keeps prices up.  If you add the loan interest to the price of the truck, you can say, with a straight face, that it is a $30,000 truck, even if it is worth closer to $25,000.

Now, of course, the best deals are not to be found in a new car dealer's showroom - or a used one for that matter.  But we'll get to that in a minute.  Let's look at the logic of financing versus rebate.

Rebates are all over the board these days.  And they annoy me, too.  Just lower the damn price on the truck, OK?  Stop playing games!  The Americans have a pretty basic $1500 or 0% (or low interest rate) financing.  The gag there, of course, is that "you don't qualify" for the financing unless your almighty credit score is 770 or above.  Toyota is offering $4000 on Tundras and Nissan $4500 on the Titan.

Do you come out ahead with the "opportunity cost" of money (another term tossed around by people who want you to make bad deals)?  Well, the theory is, if you buy "on time" then you can leave $30,000 in the bank over time and thus gain all sorts of interest money.

For example, $30,000 invested at 5% over a the term of four-year loan term will yield over $6000 in interest.  Hey, this guy is really on to something!  That beats the snot even out of the Nissan Titan $4500 rebate.  Nice truck, by the way.

Oh, but wait, we are comparing apples to oranges.  If you paid cash for the truck, that is an "investment" with no risk - paying off debt.  It is more akin to a government backed bond.  And government-backed bonds and t-bills these days are not paying more than 1-2% - which lowers your yield considerably.

In addition, over the life of the loan, you are making payments reducing the balance, effectively reducing the amount of "cash money" you had theoretically "invested" in your "opportunity cost" equation.  The first year, the balance on the loan might be $30,000, but the second year it might be closer to $25,000, then $20,000, then $10,000, then zero.

If we run those numbers at a more realistic (but still high) 2% that Uncle Sugar is paying on my 5-year T-Bill, well, you come up with $600 the first year $500 the second year, $400 the third year, and $200 the fourth year. - about $1700 or about the same amount as the Cash Rebate - or a lot less, in the case of the Japanese.

And of course, by the end of the loan, you have $30,000 tied up in the truck anyway, earning no interest.  So no, you don't "come out ahead" - you just bought a brand new car and paid a lot of money for it, that's all.

Of course, you know the whole joke with this sort of logic.  Our friend here doesn't have $30,000 laying around to "invest" in this "opportunity cost" scenario.  That's why he took the loan instead of the rebate.  In fact, the car makers are counting on you taking the loan - which is why the rebates are offered, but rarely taken.  So all this hypothetical "interest earned on my money" is just that - hypothetical.

It is like these sour grapes trolls who go on financial websites and say you are a fool for saving money, because inflation will eat it all up anyway - so you might as well go out and buy a Jet Ski.  You know how much they have invested - nothing.

Of course, if he really wanted to save a bundle, a better deal would be to find a 3 year-old truck like this, off-lease, for a little more than half the sticker price.  American vehicles depreciate rapidly, particularly the first few years.  A well-kept, one-owner, garage-kept example, with all service records, and low mileage, is indistinguishable from a new vehicle - and can be bought in a private party sale from an individual owner, for probably in the low 20's (assuming 1/3 depreciation in three years, which is being generous).

That's a savings of $10,000, which beats the snot out of any monies made in these hypothetical "opportunity cost" calculations.  Not only that, the "opportunity cost" in tying up $20,000 in a vehicle is a lot less than $30,000, even if you pay for it "over time".

And a truck with 36,000 miles on it is going to run nearly as long as one with 0 miles on it, new - or as least as long as you'll want to use it.  But the cost-per-mile and cost-per-year will be far less.

And don't even get me started on insurance.

But we all like to delude ourselves that we are getting a "deal" by biting on one of these "cash back" or "zero percent" things.  We tell ourselves that we are paying no interest on the loan, or are getting "free money" as part of the transaction.

But all they are, is complicated adjustments to pricing - complicated on purposed to obscure the true price and to confuse and obfuscate the underlying bargain.

There are no deals to be had, there.