Which Car Financing Term?

EASY MONEY>MONEY MATH

Which Car Financing Term?

Newly married couple Alex and Jenny are planning to buy a new car – a mini SUV worth P1,270,000. With their combined monthly income of P200,000, they figure they can put down 20% and borrow the balance from the car dealer’s financing plan. They also don’t want to spend more than 20% of their monthly income in car payments.

The dealer offered five monthly amortization plans based on a P1,036,000 loan (selling price less down payment):

  1. 12 months: P90,989
  2. 18 months: P62,238
  3. 24 months: P49,598
  4. 36 months: P35,306
  5. 48 months: P28,224
  6. 60 months: P24,137

Which plan should Alex and Jenny choose?

Answer: D or E

The first three plans (12, 18, and 24 months) exceed the couple’s threshold of spending only up to 20% of their monthly income (i.e. 45%, 31%, and 25% respectively), so they wouldn’t be able to afford them. That leaves the last three plans (36, 48, and 60 months), which are below their maximum (i.e 18%, 14%, and 12%). While the 48- and 60-month plans look very easy on the pocket (just P28,224 and P24,137 a month), the interest rates are higher.

Computing the rate based on the term, monthly payments, and loan amount using Excel’s formula (=RATE(nper,pmt,pv) where nper=number of months, pmt=monthly amortization, and pv=loan amount), we come up with the following interest rates for each plan: 12 months=9.81%, 18 months=10.04%, 24 months=13.71%, 36 months=13.80%, 48 months=13.83%, 60 months=14.06%).

While the first three plans are cheaper, the monthly cash out is beyond what the couple can afford. They actually have two good options: Option D (36 months) where they pay P35,306 at 13.80% or Option E (48 months) where they pay P28,224 at 13.83%. It’s only a 0.03% difference but the it frees up P7,082 in their monthly cash flow for other expenses, so Option E (48 months) sounds pretty good. However, there’s a tradeoff here. Stretching the loan one more year even at a slightly higher rate means they’ll be paying P83,736 more in interest expenses (P318,752 for Option E versus P235,016 for Option D), quite a significant amount. If the P7,082 cash freed up goes to other expenses, then it’s best to choose Option D, plus they get to own free and clear the car one year earlier.

But here’s another twist: if instead of spending the P7,082, they merely save it, they would have accumulated P254,952 after 36 months. Offsetting the P83,736 interest difference, they would still be ahead by P171,216. In which case, Option E is the smarter choice.

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