Estimating the Value of 0% Financing
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 talking about. They played it initially like they never heard of financing having a cash value. The place we eventually bought the car from immediately applied a cash-back figure that represented the value of low-interest financing.
A complicating factor was that I made a mistake initially with valuing the financing. I forgot about the average balance owing being only half the price of the car. So, I initially thought the financing was twice as valuable as it really was.
In the end, the price we got appeared to be better than indicated by the somewhat confusing report we downloaded from unhaggle. It’s always hard to know if you got a good or bad deal on a car, and I’m always left feeling uneasy for a while.
I don’t have much advice for most aspects of buying a car, but there are three things I’m confident about. One is how to value low-interest financing, the second is that it’s best to buy from Phil Edmonston’s Lemon-Aid guide recommended vehicle list, and the third is that it’s best to avoid debt and pay cash for cars.
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 talking about. They played it initially like they never heard of financing having a cash value. The place we eventually bought the car from immediately applied a cash-back figure that represented the value of low-interest financing.
A complicating factor was that I made a mistake initially with valuing the financing. I forgot about the average balance owing being only half the price of the car. So, I initially thought the financing was twice as valuable as it really was.
In the end, the price we got appeared to be better than indicated by the somewhat confusing report we downloaded from unhaggle. It’s always hard to know if you got a good or bad deal on a car, and I’m always left feeling uneasy for a while.
I don’t have much advice for most aspects of buying a car, but there are three things I’m confident about. One is how to value low-interest financing, the second is that it’s best to buy from Phil Edmonston’s Lemon-Aid guide recommended vehicle list, and the third is that it’s best to avoid debt and pay cash for cars.
Curious about your impression of unhaggle in the end... useful tool? Or just a way for dealers or others to get your information?
ReplyDelete@Anonymous: Hard to tell. The unhaggle report was confusing enough that it's hard to tell whether we got a good deal. Another interesting bit is that a dealer we never talked to phoned shortly after we got the unhaggle report. Since this dealer has the same owner as another dealer we did visit, maybe this was just a coincidence.
DeleteWhen I was shopping for a car, I used a bit of an inverted bid approach: I told multiple dealerships I was asking many dealerships for their best price, and that I'd choose on that basis. The details of what I was getting for my trade-in, which accessories cost how much, delivery, etc, was all the dealerships problem, not mine. Of course, they all tried to muddy the waters in various ways, but the smarter ones tried to get me a single number, as requested. The dumber ones came up with a number, and when I was leaving said they could get a better one (they didn't know how bids work, apparently)
ReplyDeleteI'd also advise against letting dealerships apply pressure. A guy I knew had a 1000$ rebate if he bought immediately; he said no, shopped around and went back there, to take the deal. The dealership acted all surprised and said it was a 1-time offer. "You really won't sell me a car this week at the price you were offering last week" ? My friend got it at last weeks price. Of course, all these tricks work best when going for a new car, when it's easier to compare only on T&Cs since the cars should be identical.
@Anonymous: Interesting approach. A long time ago I read similar advice to send faxes to many dealers asking for bids. The idea was that they'd all know there were many competing bidders and some of them would offer good prices.
DeleteI didn't notice any of the dealers I talked to trying to apply time pressure. But maybe I ignored it and forgot about it.
I think an easy way to ball part cost of low interest financing is to feed the MSRP, financing period and rate reduction into a mortgage calculator. MSRP will be mortgage, down payment is zero. The sum of interest will be the amount to be paid to repay the 'mortgage'. To get a more accurate number one should play with mortgage until sum of mortgage and interest are equal to MSRP
ReplyDelete@AnatoliN: That's a good way to do it, but I like to be able to estimate in real time while negotiating. In the end, I'm just looking for a starting point to negotiate further down from the MSRP minus the financing value. But if you've got the time, calculators give more accurate results.
Delete