‘Zero down-payment’, ‘0% financing’: these banners have become a normal sight in front of auto dealers. But what does this mean for buyers, sellers and the banks?

Although the term was not explicitly used, this article from the Financial Post discussed a great deal the time value of money for buyers, sellers and loaners. If any of us have been considering buying a new car, we would have noticed that many dealerships are advertising longer amortization periods with extremely low interest rates. We learned in class that this means that the value of the money returned to banks is decreasing more and more as we move further into the future. As well, automobiles are a depreciating commodity. If the customer defaults on a loan and the financing term is very long, the collateral that the bank collects will not be worth very much. The question is: what is the break-even between collected interest and depreciation? Hopefully the banks have learned from the last financial crisis.

From the consumer’s POV, ‘0% financing’ seems like a good option because they can keep more cash in the present, and present value is always worth more than future value. On the other hand, some dealers are willing to give greater discounts if you are willing to pay cash up-front than if you choose financing because the present value of the cash will also be greater than the future value of collected payments.

Considering the time value of money is crucial: banks need to be careful about the break-even point and buyers should not always jump immediately to 0% financing.