Beware the car-loan catch
If dealers are not charging interest on their finance packages, they need to make up the difference in other ways. Photo: Quentin Jones
No-interest or low-interest car loans are the latest salvo from car manufacturers desperate for sales. When a car dealer offers you money for nothing, there must be a catch, right? Well, yes and no.
The good news is that special advertised rates of 0 per cent to 1.9 per cent interest from car makers such as Holden, Ford, Nissan, Toyota and Kia do deliver on their promise. The catch is, you may end up paying more for your new car than you would if you had shopped around and paid cash, or even if you had taken out a personal loan.
Interest rates for new-car loans are typically 2 per cent or more higher than mortgage interest rates.
According to loan-comparison site Canstar, rates on standard car loans range from 7.99 per cent to 10.75 per cent, compared with the average standard variable mortgage rate of 6.19 per cent. This is because cars depreciate quickly over the first 18 months so lenders are unable to recoup the full value of their loan if the borrower defaults.
Recent research by Canstar found that 2011 models of the Holden Commodore and Ford Falcon had already depreciated by 60 per cent and 55 per cent.
People who lease a vehicle for business can claim depreciation against their taxable income, but personal buyers foot the bill themselves.
If dealers are not charging interest on their finance packages, they need to make up the difference in other ways. For starters, the price of a vehicle with a special low- or no-interest deal is often non-negotiable. Buyers who are prepared to shop around may be able to negotiate a cheaper price elsewhere.
"Typically, the new-car price is higher than you could get elsewhere and the trade-in value on your old vehicle is lower," a finance broker with Willow & Oak, Adam Smyth, says.
Smyth cites the recent example of a 0.5 per cent finance deal on a new car valued at $47,500. After shopping around, the buyer was able to negotiate a price of $40,700 for the same model car with a different dealer. Even after taking out a standard car loan, the buyer was ahead at the end of the loan term.
Canstar analyst Chris Groth says the low-interest loans offered by dealers are typically only offered for limited terms, such as three years.
To pay off a vehicle over that time requires larger repayments that can stretch household budgets, so buyers often opt for a residual, or balloon, payment at the end of the loan.
Using the example of a 2013 Holden Commodore priced at $43,790 with 0.5 per cent dealer finance over three years, the total cost of the vehicle at the end of three years would be $44,109.99. This is only $319.99 more than the purchase price, but the monthly repayment would be $1225.28.
Groth says that by opting for the maximum 30 per cent balloon, you could decrease the monthly repayment to $857.69, but you would be left with $13,137 to pay after three years.
You can make the balloon payment in cash, take out another loan at prevailing market rates, or sell the car.
If you opt to roll over into another loan, Smyth says some dealers will contract this into the original deal at a rate that may not be the best on offer.
Groth says people on a limited budget may be better off buying a used car with a personal loan (see table).
"Say you buy a one-year-old Commodore for $26,250 at a rate of 10 per cent over five years, your monthly repayments will be $553.13. That's $304.56 extra a month in your household budget [compared with the new model of the same car] and you own the vehicle outright at the end of the term. Over five years, you would be $12,118 better off," he says.
Some dealers also offer a future trade-in at a guaranteed price. On the surface, this gives buyers peace of mind, but it doesn't come cheaply.
Smyth looked into one deal where a subsidy of $6000 had been added to the retail price. In other words, the buyer was paying for their buy-back upfront.
There were also various restrictions that increased the probability that the customer would not qualify for the buy back when the time came.
"Without knowledge of the true value of a car, buyers can get caught out. It's a matter of doing your homework so you know the value of the vehicle and your trade-in. If you don't, you are boxing with shadows," Smyth says.