Car Finance, the Beach and Free Lunches

We here at iGenWealth have been talking about what we’re going to do in the glorious weather forecast for the weekend, which got me to thinking: swimming pools, beaches, the coast and convertible sports cars. But which is the right vehicle to enjoy these activities in, and how should we go about obtaining the funds to do so…?

Everywhere young people go, marketing for new cars (and finance to boot) is thrust in our faces; it’s on billboards, in magazines, on TV and even at the movies. Images of Ken and Barbie types smiling like Rob the Dentist as if they haven’t a care in the world. You think to yourself, “Wow that looks enticing! And with a mere 2.9% interest that means I can have the same carefree life!” We want to tell you that it’s true, but it is debatable when you break it down…

Usually when it sounds too good to be true it…well, is – like the basic economic principal of “no free lunch”. Someone always pays, and when an interest rate is lower than the RBA cash rate we spoke about two months ago, that someone is usually the buyer. The term is ‘subvention’ and in basic terms it can go something like this: when a car yard offers a low interest rate, they may have an arrangement with the finance company where the finance company can receive compensation for the low interest rate.  The cross subsidisation can then potentially be built in to the sale price of the car.  If this is the case, not only is the buyer potentially paying more for the car, but also interest on the inflated price. Moral of the story: if you absolutely have to borrow ask the dealer for a cash price and don’t discuss finance until you are rock solid on a price. Now I would like to present two scenarios to you.

At one stage or another we have all heard some fossil say something along the lines of “Save your money to buy a car, don’t borrow it – you kids want everything now!” And the general response using your inside voice is “Shut up gramps, what would you know!?” But slowly (as one fossilises) we may start to realise why that statement is made:

Charlotte and Edward both finish uni at the same time in 2007. Lottie heads off to work at an accounting firm and Ed to a local law firm. In this perfect world they are both paid 50k a year. They find that after Lottie’s obsessive shopping habit, hair and makeup bills and Ed’s gym membership to pump up his guns along with his booze-hag weekends and the odd holiday here and there they can each save $1,500 a month. Ed wants a new machine and hits the dealerships to get his mitts on a brand spankin’ new Subaru Outback. He bargains with the salesman and they come to a cash price of 33k. Ed then hits the net and finds himself the best interest rate, taking into account all fees (comparison rate) of 9.52%. This makes his repayments $680.08 a month for 5 years. He puts the other $819.92 into an online savings account at 5%. Ed is killing it (perhaps); has the shiny new wheels and is still saving some dosh, sorted. Lottie on the other hand thinks a bit differently.

She holds onto her old rust bucket for another 12 months and saves her cash in the same account, netting $18,495. She then goes out and buys a 5 year old Outback for 18k cash, holds onto it for 3 years before upgrading to another 4 year old chariot (the same as Ed’s) funding the difference after trade in from her savings account. So after 5 years and assuming a 3% a year pay rise (and 3% rise in savings) Lottie and Ed have the same year and model car, but have just gone different ways about it.

Their romance has blossomed and Ed gets down on one knee, recites the poem he has been concocting in his head since the day they met and so bowled over is Lottie she says yes. Ed is in the good books! This means it may be time to look at buying a house. They compare savings accounts as a means of getting started. Ed goes from hero to villain when they discover Lottie has $81,328 in the piggy bank while Ed only has $62,005. Lottie and Ed have ended up with the same car but Ed has ultimately paid 19k more for his and so has19k less to go towards the “Great Australian Dream”.

So as you drive past Ken and Barbie down at the local beach just ask yourself; “Do they actually own that BMW convertible or does the bank have a firm grasp on it?”

Have a good weekend team!

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By George Friend.