Analyzing Interest Rates: When Is 2.99% More Than 5%?

analyzing interest rates

When analyzing deals, you must pay attention to more than the interest rates alone. In the past few weeks, GM published an offer for a 2020 Escalade. The offer was either for 2.99% APR, or a $9,500 rebate. Is the offer all it's cracked up to be? Let's find out.

The MSRP, or sticker price, of the Escalade is $76,490. The Dealer was offering it at a $1,500 discount. So $74,934.

In order to get a full understanding of the difference between these two deals, we'll use the Loan Analysis calculator.

Step 1

The first step is to assess the offer at 2.99% financing:

So above, the 2.99% over a 72 month period, creates a monthly payment of $1,138.19.

Step 2

Now, let's determine what the rebate will look like.

Above, we've calculated the balance as $65,434 since we're accounting for the rebate. This can either be a cash payment or a loan, but we're treating it like cash and using a rate of 0%.

Step 3

Now that we've created a baseline for both offers, let's look more closely at the 2.99% incentive. First, copy the monthly payment of $1,138.19. Then press the “Alternate Payback” button on the rebate side next to “Monthly Payments,” and paste it into the alternate payback box.

What you're seeing above is a comparison of the 2.99% payback schedule, compared to our 0%. It turns out that the “actual” rate being charged by GM is 7.72%, by opting into their 2.99% deal.

Step 4

We're not done yet. The above comparison is 0% to 2.99%, but what if you compared it to another bank rate? Choose a reasonable bank rate to use as the interest rate, so you can further compare the difference. Below, we'll use 5%, which is actually a bit high.

The result? A monthly payment that is lower than the 2.99% And not only that–there's also a cumulative gain (of excess payments) of $6,075 over the 72 month loan period, despite the “higher” interest rate.

Step 5

The next step is to do a direct, side-by-side comparison of the two loans. The excess, after all, can be saved. So let's add a “Net Earnings Rate” on the rebate side, at 4%. Then press “Compare” under loan view.

What we see above is a little bit of earnings, if you were diligent about saving the excess.

Step 6

Take it a step further, and apply the excess to paying off the loan instead. What happens?

As it turns out, the loan on the right will be paid off 6 months sooner. And if you're a disciplined saver, you can sock away the money you would have paid during those last six months. That's a compound gain of $7,053.

Step 7

And since we're already discussing savings, why not go a step further? If your loan is paid off, you now have the ability to continue saving the gain without feeling a difference. So let's say you decide to keep this Escalade for 30 more years, and saving all that money.

At the top center, change your illustration period to 360 months (30 years).

WOW! $18,390 extra for exactly the same cash flow as the 2.99% “deal” even with a higher rate.

In answer to the original question–when is 2.99% more than 5%?–when you are comparing apples and potatoes (no, not oranges. At least those are also fruit) you'll see what you're told to see. The math is correct but the car manufacturer would have us believe we could compare the 2.99% to a bank rate of 5% when the amounts of money being financed are entirely different.  

In order to get the 2.99% “deal,” GM has already added an additional $9,500 as a “finance charge” or “additional interest” to the price of the car on top of the 2.99% they will be charging each year. That's why, compared to the rebate option, the rate is actually higher. Because with the rebate, you're financing the car at a lower price.

Further study shows the lease option:

The lease option is $958/month for 36 months, with a 10,000 mile/year maximum usage. On top of that, you have to give the car back in 36 months (or buy it for the residual value).  This is impossible to calculate accurately without all of the information (Up front signing cost, lease fee, etc.)

We can, however, see what a used 2017 Escalade with less than 30,000 miles costs, and get a ball park estimate from there.  Using the same luxury class Escalade as above, a 2017 under 30,000 miles is around $46,000.

So, using the “Interest Rate” financial calculator, we will put -46,000 as a future cost for the buyout, which would look like this:

This ends up being the most expensive option, at 8.89% and has the limitation of only 10,000 drivable miles a year. There is, however, the flexibility to walk away at the end of the lease, or lease a new car.

When most people calculate a lease option, they leave out the future “buyback” price as a future value cost (negative value). Leaving out this cost makes the lease look significantly better than it actually is. And in our case, the 8.98% cost is probably lower than it would actually be, since we're lacking information on any up-front fees.

If you do have information on the fees, simply deduct them from the initial loan balance to show the true cost. This idea may be hard to understand unless you think of it in terms of a bank loan. What would happen if you paid extra money up front on your loan? It would reduce the amount borrowed.

Here's an example using $1,200 in up-front fees:

You can see that this pushes the rate cost up to 9.71% because of these additional costs. In other words, the costs reduce the loan, but the payment stays the same.

The Whole Truth

As you can see above, what you see is often not the Whole Truth. Mathematically, things may check out, but when they're compared with different variables (or obscured variables), interpretations get messy.

When you're working with clients, or even with your own purchasing decisions, Truth Concepts can help. Remember, if something seems to be too good to be true…dig a little deeper. Check out the new Truth Concepts app for investigating deals on the go.

And if you're looking for more ways to show your clients the massive benefits of whole life insurance, explore the whole life insurance calculator.