Last time, we discussed the decision some consumers are faced with when buying a car in that they’re offered a choice between a promotional interest rate or promotional cash back.
Another item to consider is: what happens with the promotional cash back?
Is it more beneficial to (as some dealers do) automatically put the cash back towards the price of the car? Or would it be better to keep the cash in hand?
The present value principle applies here as well. In this case, the main decision depends on whether one is receiving a higher return on their investments than the interest rate they’re paying on their debt.
The one caveat to this principle, however, is the conceptual understanding that cars lose a ton of value over time. This loss is called “depreciation,” and what it means is that you can buy the car for one price on the lot, and it will be worth a lot less as soon as you drive it off (as a hypothetical example).
This article from www.Edmunds.com illustrates how much a car depreciates over its life, and offers some advice on purchasing a used car.
Reference: “Beat the Depreciation Curve When You Buy Your Next Car”, Phillip Reed for www.Edmunds.com, 01/25/2016
Given this principle, it’s not necessarily a wise choice to apply the cash back to an investment and pay interest on the car, even if the borrowing rate is lower than the rate of return.
A good rule of thumb is this: if you don’t know how to calculate exactly how much more your investment return needs to be to justify paying interest on the car and investing the cash, it’s likely your investment’s return isn’t high enough to justify paying interest on the car – don’t invest it; pay down the loan.
For those who would like to get details specific to their situation, please e-mail the author for further guidance.
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© Fernando Machado, 2016.