Why not buy the BMW, sell it for cash, and hold on to a 1.9% loan?
June 17, 2011 10:16 PM   Subscribe

I have a line of credit at 10% annual interest with my local not-for-profit credit union. BMW of Seattle is currently advertising new cars at 1.9% APR. I don't know much about finances or economics, and I don't plan to buy a BMW, but I understand that the loan is unsecured, while the car is secured debt and not a big risk for the lender, but isn't that a huge difference for someone with a perfect credit score? Why the discrepancy?
posted by halogen to Work & Money (12 answers total)
Unsecured debt costs more, and revolving debt costs more. (For comparison sake, credit card APRs can go up to 20-something %)

Meanwhile, BMW is offering that loan at a discounted rate to get you to buy a car.

A better comparison might be to see what the credit union's rate for a car loan is. It's probably more like 5 or 6%.
posted by gjc at 10:27 PM on June 17, 2011

Best answer: Why the discrepancy?

A car loan for someone with good credit would normally be in the 5% - 7% range. What BMW is doing is reimbursing the lending company for the balance of the interest to knock it down to 1.9% and charging that cost as a "marketing expense" used to incentivize people to buy their cars.
posted by deanc at 10:29 PM on June 17, 2011 [2 favorites]

Best answer: My understanding is that the rates on auto loans are often subsidized by the car companies themselves as an incentive to purchase the car.

This is particularly evident with zero-percent financing, which is obviously unsustainable (except in a deflationary environment) if you're looking at it from the perspective of a financial institution making money on interest. But it makes perfect sense if you're a car company looking to move units. Giving up a few hundred bucks in interest over the next few years might make the difference between a sale today and a lost customer to a competitor.
posted by Kadin2048 at 10:29 PM on June 17, 2011 [1 favorite]

Best answer: To answer the title line of your post, you would need a lien release from BMW's financial-services folks before you could transfer the car's title to a new owner, and they wouldn't give you that until you paid off the loan. (Plus there's the whole massive-first-year-depreciation thing.)

While the BMW rate is subsidized, it's probably not subsidized much -- my credit union currently has new-car loans at 3.25%. They also have personal lines of credit at 7%, so, unless your payment terms are particularly generous or your credit isn't so great, you may want to shop around.
posted by backupjesus at 10:58 PM on June 17, 2011 [1 favorite]

Best answer: Keep in mind that the advertised promotional rates are generally quoted for those with excellent credit. They aren't giving that rate to everyone who walks in off the street, which allows them to advertise particularly low figures.

Car loans are also fairly short term. One of the major risks of lending out your money is opportunity risk: when you write a 10-year loan at 5%, you can't use that money for a more profitable investment opportunity that emerges later. Compared to a couple year car loan, a line of credit might cover a much longer time-span.

There's also the handy funny business going on that cars aren't generally sold to consumers for fixed prices. Many dealers are going to try to make you negotiate based on your total monthly payment, and buyers tend to go along because that's the bottom line that helps them decide whether they can afford the car. When you do this, it's a lot easier for the dealer to fudge in an extra $35/month, which doesn't seem like a whole lot, but it winds up being $1260 over a 36-month loan, which more than pays for the discounted interest rate.

The special financing might only be available on certain models or packages and is probably only advertised for a limited time. This is a powerful tool to steer customers toward more profitable options for the manufacturer or to encourage buyers to act fast lest they miss out on a great deal.

The fine print may have some pretty huge limitations on the low rate if you are late or default. This is especially common in credit cards, where you see things like a 0% interest offer for the first year, but a single late payment triggers not only a late fee, but also a penalty APR of 30% applied retroactively to the entire balance. This can subsidize the costs for those who actually do pay on time.

But I think that the secured/unsecured distinction is greater than you're considering. Yes, a person with a "perfect" credit score is a fairly low risk, but there are still a lot more reasons why he might default on a personal line of credit. Even people with perfect credit lose their jobs, have debilitating accidents, get robbed or swindled, suffer massive losses in natural disasters, and endure the many other calamities of life. With an unsecured loan, that money is gone, and unless the debtor gets back on his feet quite quickly, the debt will probably be sold off to collections and considered a loss for the lender. Car loans are a lot safer because the car can be repossessed and is insured against most forms of loss. The lender might not come out ahead on the loan, but they have very a good chance at getting most of their money back. Besides, saying "pay up or I'll take away your car" is often a much more meaningful threat than "pay up or I'll keep calling you during dinnertime and ruin your credit."

As for your question "Why not buy the BMW, sell it for cash, and hold on to a 1.9% loan", I'm not sure if you're joking, but if not, the simple answer is that the finance company won't let you do this. When you have the loan, they have title to the car, and you can't sell the car and keep the loan at the same time. You wouldn't really be selling the car because you don't own the car yet. Your buyer would refuse to buy a car that you don't really own (unless you're defrauding him, which isn't really the point) because then he wouldn't own the car until the loan was paid off. Similarly, you don't get to buy a million dollar house with a 30 year mortgage, flip the place for cash, and wind up with a million dollar cash loan.
posted by zachlipton at 1:54 AM on June 18, 2011 [4 favorites]

The 1.9% loan is subsidized. I can get an unsubsidized (or market-rate) car loan from my credit union for 3.99%; BMW is basically choosing to subsidize the 2% difference in the hopes that it will get you to buy the car.

And you might be able to do a bit better than 10% on your line of credit by shopping around. Looking at the loan rates my credit union is offering, for example, they say that a line of credit is at 8.5%, and somewhere out there will be a credit union with an even lower rate. So the spread between secured and unsecured is not 1.9% vs 10%, but rather 3.99% vs 8.5% or so, which is a pretty reasonable spread given the different risks involved.
posted by Forktine at 4:35 AM on June 18, 2011

Best answer: In addition, the 1.9% loan on the BMW is for a fixed term while the line of credit is not. What this (often) means is that the interest payments are essentially front-loaded on the car (like they are for a mortgage) while the line of credit loan is more like a charge card balance where the ratio between principal and interest is relatively constant across your payments.
posted by DrGail at 4:44 AM on June 18, 2011

Another reason unsecured credit lines are so expensive is because there is little (maybe no) market to securitize them. Securitization provides banks lenders a cheap(er) source of capital from which to make car loans or allow credit card balances to accumulate.
posted by MattD at 5:37 AM on June 18, 2011

There's also the handy funny business going on that cars aren't generally sold to consumers for fixed prices.

To expand on this, in addition to the interest rate on the loan, there are all sorts of things that dealers try to tack on to the price of a new car to pad their profits: advertising fees, paperwork fees, prep fees, "appearance packages" (AKA a wash and maybe wax), and on and on. How this money is split between the dealer and manufacturer is a well-kept secret. Also, once they sell you that car they hope to continue to make money servicing it. Not to mention that once you show an interest they may try and bait and switch you into another model that just so happens to not qualify for that rate.
posted by TedW at 6:55 AM on June 18, 2011

When I see those super-low interest rates advertised for car loans, they're usually for shorter terms than auto loans usually run. I think most auto loans are paid back over 4-5 years, but the BMW offer you're referencing is a 36-month loan, so you can get that interest rate if you can pay the loan off in 3 years. I've seen 1% or 0% auto loans offered with 1-year terms, and then in the fine print you see that if you want a loan with a longer payoff the interest rates go up closer to market rates. That "1% interest" splashed across the ad in big letters is a rate that few people will qualify for or be in a position to take advantage of. I was actually surprised that the BMW one had as long a payback period as it did.
posted by not that girl at 7:07 AM on June 18, 2011

Why not buy the BMW, sell it for cash, and hold on to a 1.9% loan?

A car lender makes a lien on the car-- the physical piece of property. That lien is tied to the car, not the owner. A buyer would never purchase a car that leaves the loan outstanding, because the loan follows the car.
posted by deanc at 7:24 AM on June 18, 2011

Supply and demand considerations suggest that it is difficult to maintain a constant price point for a product. On the other hand, when you are selling a self-image good, such as a Beamer, you don't want to take the shine off the halo by discounting, so you can use cheap financing to sell what would otherwise be an overpriced car. (Wait, wait! I owned one and I liked it very well and given that it got 175,000 on the original clutch, I agree that they are very well made; but see my first point.) The alternative, longer-term strategy is to maintain a price point by subtracting quality, which in my opinion is what Mercedes has done with their C class (32K car ten years ago cannot be same as 32K car today given the dollar vs. Euro and even mild inflation).
posted by technocrat at 11:08 AM on June 18, 2011

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