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No free ride when financing a new vehicle

Zero-interest deals negate potential cash discounts that could save you more in the long run.

Published November 15, 2012

Zero is still hero in the eyes of many cash-challenged Canadians. Nothing draws potential buyers to a new-car showroom like a giant “0%” sign plastered on windshields and dealership windows.

Financing is far and away the most popular way of acquiring a new vehicle in Canada. Leasing makes up just 17.3 per cent of the market.

A zero-interest loan sounds like a no-brainer, but George Iny, president of the Montreal-based Automobile Protection Association, cautions there’s no such thing as a free ride.

“Zero-per-cent financing is a subsidy from the carmaker of $4,000 to $6,000 on the vehicle. It comes out of the marketing budget and replaces a large cash rebate, or sometimes it’s offered as an either/or option,” he says.

Although zero financing suggests it’s free, it’s usually offered alongside a discounted cash price. Buyers have to choose one or the other, and rarely get both. Select the no-cost loan, and your effective cost of borrowing becomes whatever the cash discount would have been, typically $2,000 or more.

Spread that lost savings over your monthly payments and the effective interest rate could be 6 or 7 per cent, or more in some instances.

“The goal, when you’re offered a choice between low-interest-rate financing and a rebate, is the lowest overall cost, with capital and interest,” explains Iny. “Where the cost works out the same, you’re better off taking the cash rebate, as it’s earned immediately.”

For many Canadians, paying cash to get the maximum discount requires obtaining a loan elsewhere. One of the most popular alternatives is tapping into a line of credit, which banks award to customers in good standing. The rate, usually variable, can be surprisingly low.

“If you have a line of credit at a good rate, or a mortgage that will guarantee a loan at a good rate, it can be used to finance the vehicle purchase — on condition that you retire the loan on schedule,” says Iny.

If you’re not a homeowner, Canada’s retail banks offer traditional automobile loans, although their rates don’t look as appealing as those promoted by auto makers. But a 6-per-cent bank loan can outperform zero — if you negotiate a hefty cash discount at the dealership.

Although car companies own half of the auto loan market today, banks still write about 22 per cent of the loans, according to Maritz Research (another 24 per cent are paid in cash).

Car dealers can provide bank financing on the spot, but pay attention to the numbers. Banks lend money to dealers at low rates, but offer them a secret commission to bump the consumer into a higher rate — worth up to $600 to the dealer for a creditworthy borrower.

But there are upsides to bank financing through the dealer’s business office.

“It’s convenient,” explains Iny. “And if your cash flow is marginal, the dealer can work with you to lower monthly payments by increasing the down payment or extending the term, and by playing tricks with the trade-in allowance.”

Some automakers promote longer loan terms of six, seven or even eight years to reduce the monthly payment to the $300 to $400 range most Canadians find manageable. But Iny warns extended loans, especially for domestic vehicles, can put consumers upside down — meaning the vehicle will be worth less than the outstanding loan for most of the term.

Fortunately, everything is negotiable. Iny says multiple deposits can reduce the loan rate appreciably. If you have some cash, it’ll do more good applying it against the loan than sitting in the bank collecting scant interest.

He adds most dealers will chop a percentage off their loan rate if you threaten to take your business to a credit union. Indeed, Canada’s credit unions are keen to keep their slender share of the auto loan market.

“Credit unions offer a unique value proposition because they’re owned by their customers,” says Art Chamberlain, a spokesperson for Central 1 Credit Union, headquartered in Vancouver.

In addition to offering competitive loan rates, Chamberlain says members tend to get better treatment and guidance regarding their ability to handle the debt.

“Credit unions are cooperatives, so we’re not so interested in earning a billion dollars in the next quarter,” he says, noting some credit unions pay an end-of-year dividend to their customers, based on the amount of business they do. “We succeed by helping our members succeed.”

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