Consumers shopping for a new automobile may find a range of financing alternatives from which to choose. They may, of course, pay cash, but for many if not most the choice involves consideration of the annual percentage rate and a "cash back" incentive.
Cash back is a popular enticement that automobile manufacturers and dealerships offer in order to encourage people to buy a new vehicle. While these offers may seem like---sometimes actually are---a good deal, potential car buyers should weigh other factors to determine if the cash-back incentive makes financial sense.
Cash-Back Program
Cash-back incentives typically work like this: The car manufacturer offers a cash-back reward for people who buy a new car, let's say $5,000. A consumer goes to buy the new car from a car dealer, agrees to a financing plan and uses the $5,000 as part of the car's down payment.
APR
A new car is a major purchase, and few people pay cash for it. Most consumers obtain a loan to buy a new car, sometimes financing the purchase through the manufacturer or the associated financing department. A car loan, like all loans, comes with the interest rate expressed as an annual percentage rate, or APR. As of April 2, 2011, according to Bankrate, the average APR for a 48-month new car loan was 4.38 percent.
Low APR or Cash Back
Some car manufacturers offer a combination cash back and a low interest rate. Some of these offers are either/or, meaning the consumer may choose either the cash-back reward or the low interest rate, while others offer both cash back and low interest.
Calculation
If you're faced with a choice between purchasing a car with a cash-back incentive or a low APR, you must perform a few calculations. There are several automobile websites that offer calculators that help with this task. For example, if you're offered $5,000 cash back or a 1.0 percent APR on a 48-month loan for purchase of $24,230---with no trade-in or cash down---you'll save $13 per month by choosing the low financing over the cash-back offer.
Cash Purchase vs Low APR
Another option for car buyers is to skip financing altogether and pay for a car in cash. Buying a car in with cash saves you money in the long run as you don't have to pay interest, but it also takes a lot of money out of your pocket. As long as you aren't taking money out of your emergency funds or selling other assets to purchase the car, buying a car with cash is often a good option.
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