Monday, January 9, 2012

The Illusion of Low Financing Rates

Recently, a car ad trumpeting 0% financing caught my eye. Sounds great! I’ll take it. Just give me a 25-year amortization at 0% and I’ll drive off in my new car. Fat chance. The car company would never agree to this arrangement because the financing isn’t really at 0%.

If I could get this deal for a $30,000 car, the payments would be $100 per month for 25 years. At 4% inflation, the last payment would have the purchasing power of $38 in today’s dollars. That would be a very sweet deal, especially if $30,000 was the final price after negotiation rather than the inflated asking price.

In reality, we get to choose either a price discount (cash back) or a low financing rate for just a few years. This proves that the real financing rate is much higher than advertised. No doubt car marketers know how to avoid breaking the law, but why is this type of advertising permitted?

This reminds me of the deal my parents were offered when they bought their first house. They could get the house for one price, but if they paid a few thousand more, they would get a free car as well. This is a curious use of the word “free”.

Even for people who understand that the financing rate is really much higher than stated, the effect of these games is to confuse the consumer. One way to sort things out somewhat is to check what loan terms you can get from a bank to compare them to the car company’s financing terms.

Take the car’s price (after negotiating it as low as you can) less the cash back and talk to your bank about what the payments would be. Compare this to the car company’s payments (for the same number of years of payments). This will give you an idea of how the car company’s real financing rate compares to the bank’s rate.


  1. For someone with a secured line of credit (say a house), does it make sense to use that instead of a car loan to purchase a car?

  2. Or how about the this spin on 0% financing.

    We were considering a Mazda car a few years ago, an the very first question (after the test drive) was whether we'd be financing or buying it outright.

    I completely ignored the question and tried to talk price. This went back and forth a few times until I got so frustrated that I told him we were planning on buy the car without a loan. Only then was he willing to talk about the cost of the car.

    So 0% financing on the "sticker" price of the car sounds like a good idea, except that no one ever buys a car for the sticker price.

    I got so annoyed, I walked away and bought a car elsewhere.

  3. Car dealerships are a business, nothing is "free" even if it is advertised as such. It's all in how you want to play with the numbers.

    Good post.

    @Paul T - we just recently played this game actually with a local dealership, buying a new car.

  4. @P2Sam: Whether to use a secured line of credit for buying a car depends on many factors. From the point of view of a purely rational person, if the interest rate on the line of credit is lower than the rate you can get elsewhere, then the LOC is the best choice. However, people are not purely rational. Many people have problems paying off lines of credit because it is too easy to keep spending. Do you really need this car? Would you pay it off faster if you had a separate loan? Would you buy a cheaper car if you had to get a separate loan? These are the kinds of questions you should be asking yourself.

    @Paul T: Buying a car is a negotiation. Skilled negotiators try to gather information about their adversaries. Employers like to ask what salary you expect in an effort to offer you the minimum pay that you would accept. Car salespeople try to gather information as well. They also want to get you thinking about how you'll buy the car instead of whether you'll buy the car. I don't blame you for going somewhere else to buy your car.

  5. Although I've never bought a brand new car, I have family who has. They swear by My father was actually sent to the sight by a car salesman who was probably too honest for his own good. I guess reliable information is still a scarce commodity.

  6. @Robert: Car Cost Canada used to offer a service to actually negotiate a price for your car at 3 dealerships. I used it once in 2003. After doing my best to get a good price, they saved me $2000 more. I'm told they no longer offer this service but still have valuable information.