Vehicle "Take the promo financing and put the cash in a CD" Scenario Calculation

[ua_guy]

From a car forum... Some automakers are offering 1.9% promotional financing for 36 months. It was recommended by a forum member to take the promo financing on a new vehicle purchase instead of using savings or equity from a trade or sale of a previous vehicle and stuff it in a CD at 4%++

Car forum members often use fuzzy math to justify purchases. What say you?

Here are some basic assumptions for calculation's sake:

- New vehicle cost, out the door: $42,000.
- Financing terms: 1.9% for 36 months
- Savings/vehicle equity, personal "cash" available for vehicle purchase: $42,000
- CD rate: 4.75% for 17 months (after that, anyone's guess--)
- Loan payments can be absorbed by regular income, cash in CD not needed to pay it.

What does the math look like, and what other assumptions need to be made in order to get ahead?

[disneysteve]

I see nothing wrong with that at all. Keep your money working for you. The only thing I would do differently is I wouldn't go with a CD at 4.75%. I just checked and I could get a government bond for 5.35% with that term which makes the math even more advantageous.

Of course, I wouldn't be buying a 42K new car, so this would never happen personally, but if you're committed to that purchase, definitely take the low interest rate loan and make money on the float.

[ua_guy]

I see nothing wrong with that at all. Keep your money working for you. The only thing I would do differently is I wouldn't go with a CD at 4.75%. I just checked and I could get a government bond for 5.35% with that term which makes the math even more advantageous.

Of course, I wouldn't be buying a 42K new car, so this would never happen personally, but if you're committed to that purchase, definitely take the low interest rate loan and make money on the float.

I'm not looking at buying a new car, but the question came up on one of the car forums I frequent. CD's are compounding interest, auto loans are simple interest. Curious what the earnings/savings would actually look like, and also discussion on what happens after month 17 when the CD theoretically matures. I guess whatever the preferred investment vehicle is needs to best ~1.9%.

I think the satisfaction/security of actually owning the car needs to be taken into account too, but if the cash is easily accessible I suppose it could be paid off.

[disneysteve]

I'm not looking at buying a new car, but the question came up on one of the car forums I frequent. CD's are compounding interest, auto loans are simple interest. Curious what the earnings/savings would actually look like, and also discussion on what happens after month 17 when the CD theoretically matures..

Sorry I missed the part about it being a 36-month loan but only a 17-month CD. I'm not sure why they suggested that. Just do a 36-month investment. I can get a 3-year CD for 4.7% or a 3-year government bond for higher probably. That's a whole lot better than the 1.9% loan.

[riverwed070707]

I'm with DS here. Of course the math makes it look like you've made money during this time, but the financial miss is buying a new $42k car and all the additional costs that come with that. For funsies I'll play with the numbers:

For simplicity, I'm assuming the interest stays at 4.75% for the duration of the 3 years. During that time you will have amassed $6,274 in interest on your $42k investment.

To purchase the $42k car, you presumably have to pay sales tax. 7% is average. You also will have a higher registration fee. In my state, the registration for a car less than 10 years old is 1% of the MSRP regardless of what you buy it for - I'm assuming MSRP is the purchase price. You will also have higher insurance - I don't really know what the going rate is on a new car, but lets call it $2500/yr. Your monthly payment would be $1,201 () and over the course of 3 years, you will have paid $1,242 in interest.

3 year outcome
Car payments (principal, interest + sales tax): $46,176
Insurance: $7,500
Registration: $1,260
less interest from CD: -$6,274
Total cost of new car: $48,662

Alternate scenario, you buy a $15k used car that is 10 years old with less than 100k miles. You invest the $27k difference of what you would have spent on a car and add the $1,201 monthly payment you would have been spending on the new car each month for 3 years. In reality, you'd likely put this in the stock market since you have no short term use for the money, but for comparison sake, we'll assume its earning the same 4.75% that your CD was getting. We'll throw in $1k/yr in maintenance too since naysayers will say old cars break down all the time.

Car payments (principal + sales tax): $16,050
Insurance: $2,700
Registration: $150
Maintenance: $3000
Total cost of car for 3 years: $21,900
Value of your investment: $76,355.38

[disneysteve]

Yes, buying new is a fail, but if you compare buying new with cash or taking the low rate financing and parking the cash in a 5+% bond for 3 years you definitely come out ahead with the loan.

[bjl584]

From a car forum... Some automakers are offering 1.9% promotional financing for 36 months. It was recommended by a forum member to take the promo financing on a new vehicle purchase instead of using savings or equity from a trade or sale of a previous vehicle and stuff it in a CD at 4%++

Car forum members often use fuzzy math to justify purchases. What say you?

Here are some basic assumptions for calculation's sake:

- New vehicle cost, out the door: $42,000.
- Financing terms: 1.9% for 36 months
- Savings/vehicle equity, personal "cash" available for vehicle purchase: $42,000
- CD rate: 4.75% for 17 months (after that, anyone's guess--)
- Loan payments can be absorbed by regular income, cash in CD not needed to pay it.

What does the math look like, and what other assumptions need to be made in order to get ahead?

Seems pretty straight forward to me.
This is a version of some financial advice I heard several years ago from an investor.
Basically, he said if you want to purchase something like a new car, then you should first buy a cash flowing asset like a rental property. Use the cash flow to make the payment. Once the car is paid off, you still have the asset into perpetuity

But, in your scenario, you will come out ahead as long as the payment doesn't bother you.

[Jluke]

The interest on the CD or HYSA is taxable so you need to subtract the amount in taxes from the total interest earned.


interest on the car loan. 42,000 at 1.9% for 36 months is $1242.

interest on a 42k “savings” at appx 4% is $5244 over 3 years. Less taxes.

[scfr]

Another variable is automobile insurance, which as we know has been skyrocketing in cost.

A financing company is probably going to require you to carry full coverage. Would you do that if you paid cash? I'm guessing that most of the Saving Advice community has coverage somewhere in between state minimum and full coverage. So that extra insurance cost is going to eat away some of your CD interest earnings.

And speaking of eating away the CD interest earnings, don't forget about income tax on the earnings (edit to add: I see Jluke already brought up the taxes).

[disneysteve]

Another variable is automobile insurance, which as we know has been skyrocketing in cost.

A financing company is probably going to require you to carry full coverage. Would you do that if you paid cash? I'm guessing that most of the Saving Advice community has coverage somewhere in between state minimum and full coverage. So that extra insurance cost is going to eat away some of your CD interest earnings.

And speaking of eating away the CD interest earnings, don't forget about income tax on the earnings (edit to add: I see Jluke already brought up the taxes).

On a brand new 42K car I’d absolutely have full coverage.

As for taxes, even after accounting for that you’re still going to come out way ahead investing the cash.

[riverwed070707]

Another variable is automobile insurance, which as we know has been skyrocketing in cost.

A financing company is probably going to require you to carry full coverage. Would you do that if you paid cash? I'm guessing that most of the Saving Advice community has coverage somewhere in between state minimum and full coverage. So that extra insurance cost is going to eat away some of your CD interest earnings.

And speaking of eating away the CD interest earnings, don't forget about income tax on the earnings (edit to add: I see Jluke already brought up the taxes).

What do you mean somewhere between state minimum and full coverage?! My car is 10 years old and is worth $14k and I still have full coverage. Its $900/yr. I've dropped to liability only on the teen's 2004 and DHs 2005 as they both have over 200k miles and are worth less than $5k each but until it reaches a point where the insurance premium exceeds the replacement cost of the car in a few years time, I'm keeping my full coverage. Not worth it to save a few hundred dollars a year even if I have cash to replace my car if needed.

[scfr]

What do you mean somewhere between state minimum and full coverage?! My car is 10 years old and is worth $14k and I still have full coverage. Its $900/yr. I've dropped to liability only on the teen's 2004 and DHs 2005 as they both have over 200k miles and are worth less than $5k each but until it reaches a point where the insurance premium exceeds the replacement cost of the car in a few years time, I'm keeping my full coverage. Not worth it to save a few hundred dollars a year even if I have cash to replace my car if needed.

I mean that I guess most SA members study their options and adjust their coverage, including their deductibles, based on what makes the most sense numbers-wise. If some choose to follow whatever the insurance company quotes (or the lease company dictates), that's A-okay with me, but not my choice. For me, it's worth taking the time & making the effort to study my options. I've never gone with just the state mandated coverage, but I've also never had the lowest ($250?) deductible when I have comp & collision coverage. It's always been somewhere in between the two.

[scfr]

duplicate post

[scfr]

On a brand new 42K car I’d absolutely have full coverage.

As for taxes, even after accounting for that you’re still going to come out way ahead investing the cash.

Without crunching the numbers I don't know, but I probably agree. I was making the point that it's not a simple equation of pay x interest vs earn y interest. ua_guy did ask the question "what other assumptions need to be made ...?" in the original post.

[ua_guy]

We have to assume the insurance cost before the purchase and after the purchase is the same, same deductibles. And there would be the same insurance whether it is financed or owned.
But I agree, driving a "low value" car nets savings when it only needs to be insured for liability. I'm with DS on that one... if the car's value is <$5k, that's a good point to drop collision and comp.

42k is "out the door" so there are no additional taxes. But it was brought up that there will be income taxes on the CD interest, which is important to consider in the overall calculation.

The interest on a 42k car loan at 1.9 for 3 years is $1242.

Interest earned on a 36 month CD at 4.75% on 42k principal is $6,273.79. Depending on what the income tax is, it's still a value to put the cash into a CD at those numbers it seems.