Personal Finance
Do the homework before
buying a car
THE
LAST
WORD
Dr Larry Haverkamp
Wow, COE prices are so high
it looks impossible to buy a car. It wasn't always like that. In
Jan 2010, COEs for small car, large car and open categories were
$20,000. That was only five years ago but it seems like a lifetime.
Now, COEs are $64,000 for small cars (under 1,600 cc), and $72,000
for large cars and the open category (which is used mostly to buy
large cars).
"It's too much", you say. "I am priced out of the
market!"
Maybe not. For an easy solution to the problem,
consider a used car. They are available at all prices, even under
$10,000, although those are for nine-year old cars with COEs that
are about to expire. If you pay more - like $20,000 - you can get a
COE with two or three years left. Pay still more - like $30,000 -
and you can find cars with five years left on the COE. These are
reasonable cars which look like new. While most things in Singapore
are efficiently priced, you can still find a used-car bargain. Part
of the reason, I think, is we don't like risk, so people are
willing to pay a premium to buy a new car, which comes with a two,
three or five-year dealer's warranty. It eliminates nearly all the
risk of buying a car. This makes used cars underpriced since many
don't carry warranties, especially if sold by the owners. Even for
dealers, used car warranties are short, like three to six months.
This added risk of"going naked" (without a full warranty) is
discounted into the lower used car price.
Where to get the
money?
How about financing? Well, you can still get a car loan and it's
easier than you think.lt will probably cover 60 per cent of the
car's cost with five years to repay. A typical car loan rate is
around 2.55 per cent for a flat-rate loan, which translates to a
5.0 per cent effective rate. Why two interest rates? It is standard
in the industry to advertise one rate (the flat rate) and charge
another (the effective rate). lt's always been like that and is
highly misleading. For example, if the flat rate is 2.55 per cent
for a five-year car loan, you are really paying an effective
interest rate of 5.0 per cent. That's almost double!
Why do that? Why do banks deceive borrowers by telling
them the cost is about half of what they really pay? The best
explanation I have heard is: "It's that way because that's the way
it is!" lt's not a great explanation but it's the banks' way of
saying flat rates are standard in the industry. When quoting the
flat rate, however, banks must also disclose the true cost, the
EIR. That seems like a good solution, but the EIR is often in a
footnote or a small font. Sometimes, like when talking to a loan
officer at a bank or finance company, they only mention the flat
rate. If you ask, they may tell you that is what you pay even
though it's not.
How interest rates
work
Don't confuse the flat rate with simple interest, which is also
misleading but less so. It fails to consider the interest on
interest - called compounding - which doesn't make much difference.
For example, the simple interest on credit cards charging two per
cent per month is 24 per cent per year while the more correct
compound rate is 26.8 per cent.
That's misleading but the difference between flat
and effective rates is much more. As shown earlier, it is almost
double since a flat rate of 2.55 per cent is really a 5.0 per cent
EIR on a five-year loan.
The reason is that flat rates don't consider that
almost all loans - including car loans - pay off the principal
borrowed over the term of the loan, like five years for most car
loans. Only one other type of loan routinely advertises flat rates,
which is personal term loans, so watch out for those too. For all
other loans, like our all-important home loans, do it correctly and
quote the effective interest rate. One more financing tid-bit. Car
dealers typically have a conflict of interest but keep you in the
dark about it. They receive kickbacks for recommending a bank for
you to take your car loan. The dealer will even help you fill out
the paperwork but never mention that they receive thousands of
dollars for recommending that bank and doing the minor
paperwork.
Some of the kickback is used to lower the car's
price, but it's still a bad deal for borrowers. Recently however,
Citibank has announced it won't do that but will go to the
borrowers and offer low interest rates directly. lt seems that
everyone would flock to Citibank, but that's far from certain since
car dealers will try to keep this source of profits for themselves.
Anyway, good luck to Citibank in their noble effort.
Dr Haverkamp is an economist and
adjunct faculty member at Singapore Management University. In his
weekly series, he shares simple tips on how you can make your money
work harder for you.
Classified, The Sunday Times, October 26 2014, Pg C16