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Long post.

Oh boy! Where to begin? Let's get a few details out of the way. First, from FoolishVenturist:

>> Plus, for purposes of your argument you are assuming that the consumer HAS the entire price of the car to set down on the table. Remember, you don't get ANY rebate unless you pay CASH for the car. <<

This is almost never the case. You don't need cash to get the rebate, you just need to secure your own financing. I can get a 7.5% new vehicle loan from my bank and still get the rebate. Sure, dealer financing may be 1.9%. But, I have to "buy down" the rate for $1,500 (giving up the rebate).

This is where we need to compare apples to apples. The Truth in Lending Act requires mortgage lenders to report mortgage rates in terms of APR. A mortgage may have a low interest rate but have loan origination fees and points. With the fees expressed as prepaid interest, you get a higher APR.

What I intend to do is compute the APRs for various rebate programs and demonstrate how the APRs for dealer financing generally exceed the APR you can get if you secure your own financing.

For starters, let me address what I consider to be a reasonable interest rate. DavidBoring used 8.9% but felt even that was too low. That may be true in some areas, but I'll use my personal bank as a point of reference. Today, I can get a 7.5% new vehicle loan in the Dallas area. Here's proof:

7.5% compounded daily is approximately 7.8% APR. So, 7.8% is the number to beat, right?

>> Moreover, you are not taking into consideration the amount one can earn if you invest the money in the stock market during good times <<

This is immaterial - but you probably stated this assuming we were buying the car outright. If we were, there's no APR because there's no loan. As it is, we're only taking enough money out of the market for the down payment. Essentially, we've got a 7.8% margin loan. Since the market historically has returned about 10.7%, we'll probably still make money as you pointed out.

How much we can earn in the stock market isn't the issue, anyway. I'm trying to demonstrate how it's almost always beneficial to secure your own financing (as long as it's not on a CC) rather than take dealer financing. Apples to apples, right?

Now, let's get down to business. First, let's compute some APRs using DavidBoring's assumptions. David has given us the option of "buying down" a $13,500 loan to 1.9% for 4 years for $1,500. Computing $1,500 as prepaid interest, that's an APR of 7.2%. Yes, that's still better than the 7.8% I can get at my own bank, but in a moment I'm going to dispute David's assumption.

As an aside, what happens if we want to pay of the debt early? Maybe we sell the car after three years, pay off of the old loan, and then get a loan on another new car? The APR on the dealer financing soars to 9.0%! Whew! The DTCU loan, however, is still sitting at 7.8% APR. That's the curse of prepaid interest.

Before I go any further, let me say that if David and I met face to face, I'm sure we would get along great and he would find me friendly and diplomatic. Unfortunately, in the written media, I often come across as fiercely argumentative. Perhaps I need to use for emoticons to show that I'm not scolding, flaming, or being condescending. :-> I'll try to choose my words carefully so I don't offend. At any rate, David, just grit your teeth and say "hey, Mike's really not such a bad guy!"

Okay, the dealer financing terms you described might be available where you live, but in Dallas they're not nearly so generous. In Dallas, you'll never get 1.9% for 48 months - it's usually about 36 months. Also, I've seen customer rebates as high as $7,000 - far more than the $1,500 we originally discussed.

I couldn't find a Web site for a Dallas dealer that gives financing terms, but I did find this one in Amarillo:

Scroll down to the section for "Buick Specials". They offer a $1,000 rebate and a variety of loan terms. Assume, again a $13,500 loan, but now only $1,000 to "buy down' the rate.

If you take their 2.9% for 36 months, the APR is 7.7% (slightly better than my 7.8%). But, the 4.9% for 48 months is 8.6% APR and 5.9% for 60 months is 8.9% APR. The worst deal is the "Lincoln Special" farther down the page: $5,000 cash back or 1.9% for 48 months - that's almost 20% APR!!!

The morals here are:

1) Unless you're lucky enough to find the dealer financing terms that David described, you're probably better off securing your own financing. We can always make examples with contrived numbers to make a rebate look better, but I don't think that happens in reality.

2) If you _do_ get dealer financing and give up a cash rebate, don't pay off the loan early. The prepaid interest causes the APR to skyrocket. Paying off the DTCU loan early does _not_ affect the APR because there are no upfront fees.

3) You can reduce the effect of upfront fees on your APR by maximizing the financed amount and only making the minimum payments.

Andrew Tobias had an excellent discussion on APRs on the Ameritrade web site:

and a followup:

IMHO, dealer financing/rebate programs should be bound by the Truth in Lending Act the same way as mortgage lenders.

I support FoolishVenturist's assertion that it's often better to borrow to buy a car (at today's ultra-low 8% APRs) than take money out of the market. However, have you considered getting your car loan from your broker? You could borrow your $13,500 from a Datek margin account at 7%. What's better is that, unlike a traditional car loan, margin interest charged to a brokerage account is TAX DEDUCTIBLE (with conditions)! Cha-ching! In the 28% tax bracket, your car loan is now 5.2% APR. I challenge you to find a dealer who can beat _that_!

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