You have heard of the Truth In Lending law. The idea is to provide interest-rate information honestly and consistently so that people know the interest rate they’re paying and can sensibly compare loans.
Now comes reader Erik Sten with a refinement.
With regard to those “2.9% financing or $1,500 cash back” deals one so often sees, Erik suggests that the 2.9% may not be 2.9% after all. Accepting that it means paying $1,500 more than necessary for the car, that foregone $1,500 really should be considered part of the cost of financing the car.
So what is the interest rate really?
Say you are buying a $12,000 Ford Escort LX 4-door, which is more or less the example Erik supplied me with last summer. The dealer was offering 2.9% or $1,500 cash back. The regular 48-month car-loan rate available to people with good credit at the time, Erik says, was 8%.
Well, on a $10,500 48-month car loan (assuming you were financing all but $1,500 of the $12,000 purchase), the payments are $231.95 at 2.9% and $256.34 at 8%. So you save $24.39 a month or $1,170.72 in interest over four years. But you don’t save $1,500 – and what you do save, you don’t save all at once. No, the prevailing interest rate would have to be 9.4% or so for a 2.9% rate to save you $1,500 over four years. And because $1,500 up front is better than $1,500 spread out over four years, the “true” interest rate would have to be nearly 10.5% for this 2.9% rate to represent an equivalent saving.
Still not terrible, and not necessarily something to pass laws or enact regulations over. But to the extent the 1.9% and 2.9% financing deals make the average car buyer even less likely to pay cash, and thus even more likely to pay what may amount to 10% interest that’s not tax-deductible, it compounds a common consumer error; namely, someone who unwittingly earns 5% in a savings account (which may be 4% or less after taxes) while at the same time paying 10% to finance a car. Borrowing at 10% to earn 4% is no quick way to get rich.
Is truth-in-auto-lending a problem? Worth a crusade? Let me know your thoughts and I’ll pass them on to Erik.
Quote of the Day
Burn down your cities and leave our farms, and your cities will spring up again as if by magic; but destroy our farms and the grass will grow in the streets of every city in the country.~William Jennings Bryan
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