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What’s Better – Cash Back or 0% Financing?

By JLP | February 19, 2007

We all see “Cash back or 0% Financing” advertisements all the time. Have you ever thought about which deal is better for you?

Let’s say you are looking at a Chevy Impala. Right now, Chevrolet is offering $3,250 cash allowances or 0% financing for 60 months on the Impala (the website doesn’t say anything about a downpayment so we’ll assume there isn’t one). We’ll say the Impala normally sells for $26,000. For this little exercise we will assume that there are two ways you can buy this car:

1. Finance $22,750 ($26,000 – $3,325 = $22,750) through a third party at 6.25% (the best rate I could find through a local credit union) for 5 years.

2. Forgo the cash incentives and take the 0% offer for 60 months.

Assuming you want to buy this Impala, which way is the best way to go?

Here’s the math I came up with:

Buying a Car Comparison

According to these numbers, it is better to go the 0% route. This doesn’t mean it is ALWAYS better to go the 0% route. You have to do the math yourself to find out which way is best for you.

I also did a calculation in Excel to find the breakeven point in the interest rate that would make 3rd party financing the better deal. I came up with 5.38%:

Buying a Car Comparison

That means that if you could find an interest rate lower than 5.38%, you would do better by going the 3rd party route instead of the 0% offer.

That said, this post is not advocating you go out and buy a new car. In most cases you would do better to buy a good used car.

Topics: Budgeting, Cars, Financial Math Basics | 14 Comments »


14 Responses to “What’s Better – Cash Back or 0% Financing?”

  1. Fred Says:
    February 19th, 2007 at 5:44 pm

    To really answer the question you have to determine if by investing the $3,250 you would earn more than $548 in 5 years.

    If you invest $3250 at 4% for 5 years, you’d have $3,968.24, which means you’d actually make $170.24 by taking the cash back.

  2. Miguel Says:
    February 19th, 2007 at 6:05 pm

    I would approach this as thinking about the 0% financing as not really 0% financing, since you have to pay more for the car in order to get the financing.

    If you look at the $3,250 as essentially an upfront financing costs not unlike points on a mortgage (i.e. you give up the oppty for the $3,250 incentive in order to take the “0%” financing option), then the choices become clearer. The “upfront” oppty cost of $3,250 equates to an implied interest rate of 2.7% over 5 years:

    n = 5
    PV = 22750
    FV = -26000
    Solve for I = 2.707%

    So, if I could find financing at better than 2.7%, then take the incentive and finance w/3rd party, otherwise I’d take the 0% option.

    In reality, I’d probably be a cash buyer, so different analysis altogether. The 0% offer would be mightly tempting considering how much I could earn by leaving my money invested.

  3. Miguel Says:
    February 19th, 2007 at 7:27 pm

    That should read: So, ASSUMING I NEED TO FINANCE THE PURCHASE, if I could find financing at better than 2.7% [very unlikely], then I WOULD take the incentive and finance w/3rd party, OTHERWISE I’d take the 0% option.

  4. tinyhands Says:
    February 20th, 2007 at 10:57 am

    One note from the real-world: Read the fine print on those 0% deals and consider your own likelihood of missing a payment. (i.e. Are you barely above living paycheck to paycheck? Is your budget flexible enough to support ‘what ifs’? Do you have a realistic emergency fund?)

    One missed payment can cancel the whole deal and you may find yourself suddenly paying 10% or more. Although dealers are supposed to qualify you for 0% financing, it’s still in their best interest to move the cars.

  5. Miguel Says:
    February 20th, 2007 at 11:35 am

    Good point tinyhands. I wouldn’t doubt that one late payment, even late by a day, would trigger some nasty rate for the remainder of the loan. My comments were only approaching this as a brain-teaser in answer to JLP’s question.

    In reality, I would be inclined to pay cash for the car – I’m all about simplifying my personal finances and don’t want any consumer debt, however attractive, not to mention one more bill to keep track of.

  6. Jesse Says:
    February 20th, 2007 at 11:42 am

    I’d like to see a continuation of this post where you take the cashback and invest it, as one of the above posters mentioned. Nice post though. I’d be inclined to buy used and pay cash.

  7. JLP Says:
    February 20th, 2007 at 11:46 am

    This post was actually challenging to put together. The problem with taking the cash back and investing it assumes that you have the cash in the first place. I was trying to make this illustration as simple as possible.

    The very best route (if you are buying this particular car new) would be to take the cash back and pay cash for the car.

    Jesse,

    I’ll see what I can come up with.

  8. Chris Hynes Says:
    February 20th, 2007 at 12:16 pm

    If you’re getting cash back and investing, I’d assume you’d want to do an analysis based on financing the whole amount both ways. In other words, both scenarios should have you taking out a 26k loan on the vehicle. In one, it’s 0%… in the other, you invest the cash you get back.

    BTW, my credit union (Navy Federal) has car loans starting at 5% in case you want to use that number in your calculations. Link: http://navyfcu.org/rates/lease-frameset.html

  9. Miguel Says:
    February 20th, 2007 at 1:49 pm

    Chris,

    I would approach this as if you are buying a car valued at $22,750 (what they’re really willing to sell it to you for). You have several options:

    1) Pay cash, which means giving up investment returns on $22,750. Let’s assume you can get at least 8% ROI on your invmnts – that’s a big oppty cost.

    2) Borrow at an upfront cost of $3,250 (an implied rate of 2.7% as described above).

    3) Borrow elsewhere at commercial rates (guessing 5-10%)

    So, #3 is going look expensive relative to #2. And if you get something like 8% ROI on your funds, #1 less attractive than #2, so in theory, #2 wins.

    I’m ignoring the fact that the loan probably amortizes, and should adjust all calculations for time value, etc., and also ignoring some optimal combo of the options, but that’s way more work than I’m willing to put into it.

  10. J.D. @ Get Rich Slowly Says:
    February 20th, 2007 at 3:02 pm

    Hm — why not run the numbers on other price points. For example, with a $20,000 vehicle you’re better off taking the cash back. At some point ($23,000?) there’s going to be a crossover point at which it makes no difference, but for lower-priced vehicles cash back makes sense.

  11. Rob Says:
    February 20th, 2007 at 6:02 pm

    Another important point is that this assumes you will actually keep the car for five years. Paying the higher price for 0% financing is basically like paying points on a mortgage, the longer you intend to keep the mortgage the more sense it makes. I would guess that the break-even point for the 0% financing to be better is probably around 4 1/2 years.

  12. fivecentnickel.com Says:
    February 23rd, 2007 at 5:06 am

    Weekly Roundup – 02/23/07

    Here’s a quick look at some of the articles that caught my eye over the past week…

    Jim points out that Citi writes checks for 0% balance transfers.
    FMF advises you to save money by buying the right garage door. Failing that, my best advic…

  13. Blaine Moore (First Time Home Owner) Says:
    February 23rd, 2007 at 8:16 am

    Rob has the right of it; are you going to keep the car for 5 years? Is it still going to be worth making payments on 5 years from now? Could you wind up upside down on your payments if you had an accident?

    Personally, if I had the cash to pay for it outright (optimum situation), then I would probably take the lower price, put a sizable down payment in place, and then pay twice or thrice the monthly bill. That way, I pay less for the car all-in-all, I still have some money to have invested, and I’m not stuck under a loan for as long.

    Realistically, though, I don’t plan on purchasing a new car. I’d rather get a car that’s a year or two old, has around 15-20000 miles, and only costs $10-12k that I could pay cash for. I don’t currently have savings to pay cash for a “new” car, though, so my plan is to make my truck and my wife’s car (both owned outright) last for as long as possible. In my truck’s case, that should be at least 4 or 5 years, in which time I will probably be looking for something more baby friendly anyway.

  14. Greg Says:
    March 7th, 2007 at 9:05 am

    Be agressive. See how far below “cash back” you can negociate. When you go to F&I, ask for 0%. If they say “No,” you can always walk.

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