I don’t often have much to say about macroeconomic issues, but an article “sounding the alarm” about how interest rate increases are affecting car companies drew a reaction. “Aggressively raising interest rates has helped create an untenable situation in car financing.” Good.  Financing a car is usually a mistake for the consumer.  When consumers’ credit is so bad that they can’t even get a car loan, it’s even clearer that they shouldn’t buy the car. “The auto sector is one of the victims of the aggressive interest rate hikes.” Ridiculously low interest rates have allowed car companies to inflate prices and sell ever more cars to people who can’t really afford them.  The fact that the party is ending doesn’t make car companies victims.  Conditions are just slowly getting back to normal. “Rising interest rates will make consumers reevaluate their decisions before quickly jumping into a car loan.” Good.  It’s sad when people bury their financial future by buying ...

A persistent myth is that you don’t pay compound interest on installment loans, such as mortgages, car loans, and other personal loans.  I’ll show that this is nonsense. One example of this myth comes from an Investopedia article on car loans : “Auto loans include simple interest costs, not compound interest.”  The reasoning is that if your payments cover all the interest that accrues each payment period, then there is no opportunity to build interest on top of interest. However, money is fungible.  Why can’t we think of each payment as going against principal and leaving the interest owing?  Then there would be interest building on top of interest.  We could also think of payments applied proportionally.  For example, if a payment represents 5% of the remaining amount owed, we could think of the payment covering 5% of the remaining principal and 5% of accrued interest.  This proportional method is the most useful way to think about how payments apply,...

I recently helped a family member buy a new car. She was paying cash for the car, so we had to estimate the value of the 0% financing offered to figure out a sensible price to pay for the car. The key factors that matter for estimating the value of low financing interest rates are duration and interest rate reduction. For example, suppose financing is offered for 4 years at a rate that is 4% below a competitive interest rate. This is a total of 4x4%=16%. However, if the car will be paid off over 4 years, the average balance owing will be close to half the price of the car. So, the value of the financing is about 8%. For this example, you can reduce the car’s MSRP by 8% as a starting point for a cash sale negotiation. This is equivalent to paying the full MSRP and taking the financing. From there you can negotiate down from the adjusted MSRP. It was interesting to talk to multiple dealerships and take this approach. A couple just pretended they didn’t know what I was talki...

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 t...

Recently I combed through some ad fine print to show that some cars were more expensive than the ads made them seem . Yet another car ad reveals more of the same and I’m starting to wonder whether people are genuinely being fooled or whether they want to be fooled. This time I was looking at an ad for GM cars. The top car showed the price $16,498 in large font. However, the fine print says that the MSRP of the actual car pictured is $19,925. I can’t tell if that is before or after some “cash credits”. Here are a few more fun bits in the fine print: “Dealers are free to set individual prices.” “Insurance, license, PPSA, administration fees, and applicable taxes are not included.” “At some dealers, the vehicles in this advertisement are only available with additional features of glass etching (up to $424), locking wheel nuts (up to $150), nitrogen in tires (up to $399), GM tire protection plan (up to $220), mud flaps (up to $120), box liner (up to $325), Walk Away ins...

As the Big Cajun Man at Canadian Personal Finance pointed out, car companies are shying away from leasing cars . This may seem puzzling, but will make sense after looking at the true nature of car leases. The term “car lease” was great marketing. It gives the illusion that the dealership takes the risk, and you just rent the car for a while and get a new one when it suits you. The truth is that with a car lease you take much the same risks as if you buy the car. If something happens during the term of a car lease that makes the car worth less than expected at the end of the lease, you’re on the hook and will have to make up the difference. The best way to think of it is that you own the car, but owe a lump sum at the end of the lease. If the car happens to be worth as much as this lump sum owed, then you’re okay. If not, dig into your wallet. When leasing a car you have lower payments than if you took out a loan, but this just means that you’re paying it off more slowly. In fac...

According to Bloomberg, General Motors will begin offering no-interest car loans on certain pickup trucks and SUVs for as long as 6 years. I suppose that this indicates a certain amount of desperation to sell these gas-guzzlers, but what strikes me is the “no-interest” part of this story. Surely most people understand that they’re not really getting a no-interest loan. In reality, they are paying an inflated price that includes the real vehicle price plus the loan interest amount. For loans extended to 6 years, the advertised price is just inflated by more. Even worse, no-interest loans are often only available on fully-equipped vehicles with many overpriced options. When it comes to paying cash versus financing a vehicle, Phil Edmonston’s Lemon-Aid Guide explains the dealers’ preference for financing: “Let’s clear up one myth right away: Dealers won’t treat you better if you pay cash. They want you to buy a fully-loaded vehicle and finance the whole deal. Paying cash is n...

The invention of the car lease was a tremendous boon for the car industry. Few people can understand the financial implications of car leases, and at the same time, leases have lower payments than car loans. Many cars would not have been sold if the car lease didn’t exist. Even the word “lease” works well here. It gives the illusion that someone else is taking the financial risks of car ownership, and the driver is just leasing it. But, you are taking the risks whether you buy or lease. The idea behind a car lease is simple enough. With a 3-year car loan, the full car price is spread across 3 years at some interest rate. For a 3-year lease, the difference between the car price and its expected value after 3 years is spread across 3 years of payments at some interest rate. After the 3 years, you have to pay the residual amount (possibly by selling the car back to the car company). Naturally, a lease gives lower payments than a loan for those 3 years making the lease seem attractive. Car...