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Imagine getting a note like this:
We’re 70 and buying what’s probably our last new car. The dealer is offering a choice: 0% financing for five years, or $4,000 off if we pay cash. We have the money in savings. Which deal should we take?
Let’s say it came from a retired couple we’ll call Tom and Sue. They’re made up, but their question is one plenty of car buyers face, and the answer isn’t as obvious as the dealer wants you to think.
I’ve been a CPA since 1981. Here’s how I’d run the numbers.
First, some context. Commercial banks were charging an average of 7.54% on 60-month new car loans in August, according to the Federal Reserve. (1) So 0% looks like free money.
But the Federal Trade Commission notes that manufacturer incentives can come as lower finance rates or cash back, and that discounted rates may be limited by your credit history. (2) Tom and Sue’s dealer is making them pick one.
What decides it is what your cash earns while it sits. A one-year Treasury was yielding about 4.49% on Oct. 15. (3) The national average savings account paid just 0.37% in September, according to FDIC figures. (4)
Here are 5 steps to pick the right deal.
1. Run the math on your own money
Let’s use a $40,000 car. Option A is 0% for 60 months, or $666.67 a month. Option B is $4,000 off, so Tom and Sue write a check for $36,000.
With 0% financing, they’d keep the $40,000 earning interest and pay it down each month. Here’s my math on what that stream of payments really costs in today’s dollars:
If their money sits in a savings account at the 0.37% national average, the 0% deal costs about $39,626. The $4,000 rebate wins by about $3,600.
If their money earns about 4.49%, like that one-year Treasury, the 0% deal costs about $35,768. Now 0% wins, but only by about $230.
2. Don’t forget taxes on the interest
Interest you earn is taxable, so you don’t keep the full 4.49%.
In the 22% federal bracket, a 4.49% yield nets about 3.5%. At that rate, my math puts the 0% deal at about $36,645. The rebate wins again, by roughly $645.
My read: for most retirees, the rebate is the better deal. In this example, 0% only comes out ahead if your cash earns more than about 4.2% after taxes.
And if you’d have to borrow to take the rebate, the math flips hard. At the Fed’s 7.54% average, $36,000 over 60 months would cost about $722 a month and more than $7,300 in interest. (1)
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3. Nail down the price before you talk financing
None of this math matters if you overpay for the car. The FTC says to get an “out-the-door” price in writing before you talk financing with the dealer. (2)
It also warns: “Don’t assume that any rebates have already been included in the price or terms you’re offered.” (2) Ask the dealer to show the rebate as its own line.
And watch the payment pitch. The FTC’s advice: “Know your total cost, not just the monthly payment.” (2)
4. Say no to the add-ons you don’t want
Once you’ve agreed on a price, expect the finance office to offer extras. The FTC lists gap policies, window etching, extended warranties and service contracts as common add-ons, and says, “It’s ok to say no to add-ons, and to ask the price.” (2)
The Consumer Financial Protection Bureau adds that the price of add-ons is negotiable if you choose to buy them, and suggests comparing loan quotes from multiple lenders before you go into the dealership. (5)
5. Price your insurance before you sign
A new car can change your insurance bill, so get quotes before you commit, not after. One option is to compare several insurers at once.
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Claim an offer, pay with your usual card, and the cash back lands in the app. Start earning on your next tank.
My honest take
Zero percent sounds like the deal of the century. Sometimes it is. But $4,000 off the price today is real money, and for most retirees whose cash is sitting in an ordinary savings account, it’s the better choice.
So do what the dealer is hoping you won’t: separate the price, the financing and the extras, and run your own numbers. Tom and Sue’s last new car should be a good memory, not a five-year reminder that they took the wrong deal.
Sources: 1. Federal Reserve; 2. Federal Trade Commission; 3. Federal Reserve Bank of St. Louis; 4. Federal Reserve Bank of St. Louis (FDIC data); 5. Consumer Financial Protection Bureau
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