The business Objective of banks is to make money for its shareholders. So when the Cash Rebate scheme for Motor Loan was introduced, it seems too good to be true that the banks are giving back cash that they should have earned for its shareholders. How does this scheme milk money from the customers? Read on for a deep dive into the scheme.
I recently consider buying a new car to replace my aging but reliable MPV and visited several showrooms. All dealers have tied up with the banks to offer motor loans and a few offer the cash rebate scheme. Aha! The attractive low selling price advertised in the classifed is a result of deducting the cash rebate; On-The-Road (OTR) price is btween three to five thousands more.
What are the terms and conditions of the scheme? To get the cash rebate, you have to loan a principal of at least 70% of the car price for a loan tenure of at least seven years. Full refund of the rebate is required in the event of a prepayment within two years and thereafter, prorated refund of the rebate for the balanced months till the end of the loan. Rule of 78 computation with 20% penalty also applies to prepayment. A naive consumer like me will be attracted to the upfront cash rebate and overwhelmed by the good feeling of buying a car priced low aka “I bought it cheap” mindset.
How do you decide whether to sign up? It is not easy there and then. I created the first verion of this worksheet to help understand the specifics of the scheme in my earlier post. I have since updated it to Version 1.1, adding a chart for a better illustration. Please download it here as my analysis will also require you to change some parameters on the worksheet for a better understanding of the observations.
In the worksheet, the illustration is done using the Cash Rebate offer at 3.5% versus a traditional loan offer at 2.8%. You can see that the two loans have the same financial charges:
Example 1 - Cash Rebate scheme: total interest $9,800 with deduction of cash rebate $4,199 = $5,601
Example 2 - Traditional Loan scheme: total interest is $5,600
However, the loan tenure is shorter for traditional loan scheme is shorter at five years. Another key difference is that the monthly instalment is higher by $166 ($760 versus $594).
I believe that there is a large group of buyers who take loans with tenure of five years or less as Singapore residents are quite obsessed with having the latest model (similar to the trend in mobile phone ownership but to a lesser extent) and that has resulted in two-third (67%) of all private vehicles on Singapore roads is three years old or younger (source: Land Transport Authority http://www.lta.gov.sg/).
Now, turn to the Chart and see how much the buyer has to cough up - an additional sum of between $880 to $1,810 for prepayment within two years and between $450 to $600 from the third to the sixth year. What is the probability of the buyer keeping the vehicle till the seventh year? I reckon that it will be less than 30%. Thus, the banks are likely (more than 70% probability) to make more from the Cash Rebate scheme over the traditional ones as it encourages these who can afford full payment or short loan tenure or smaller loan principal to take a longer and larger loan.
This scheme is not bad and disadvantageous to the bank customer. Let me show the Effective Interest Rate (EIR) for the two examples:
Example 1 (Cash Rebate scheme) with principal of $40,000 with tenure of 7 years at 3.5% flat has an EIR of 6.44%.I will now introduce another buyer, probably a young working adult who endeavour to own a set of wheels but he will be putting a significant part of his monthly pay packet to finance it. He has little choice but to stretch his loan repayment period for seven to ten years. I will use an example that is easier to compare to the earlier ones - he plans to take a loan of $40,000 at 2.8% for a tenure of seven years. The total interest will come up to $7,840 and the monthly instalment is $571; his loan EIR is 5.22%
Example 2 (Traditional Loan) with principal of $40,000 with tenure of 5 years at 2.8% flat has an EIR of 5.28%.
Fortunately, the Sales Engineer attending to him recommends for him to take advantage of the Cash Rebate scheme ie. Example 1. Now, change the loan period parameter for the traditional loan to seven years for a comparison or download this file. The advantage for the Cash Rebate scheme now surfaces …. see the difference in cash outlay from the 25th month (also the lock-in period). As long as he uses the car for more than two years, he will save some costs and hitting a maximum savings of $2,239 if he passes seven years. There are two impact to him:
- The selling price of the car is lower by $4,199 and
- His monthly instalment is increased by $23 from $571 to $594.
We can also look at the loan from another perspective, starting from actual prepaid interest ie. $9,800 - $4,199 (rebate) = $5,601. A traditional loan with principal of $40,000 with a tenure of seven years would be at a flat rate of only 2.0% (EIR 3.79%). Can you find a flat loan rate of 2.0% these days? I must applaude the bank for being kind to its younger (or cash-strapped) customers.
At the end of the day, you should consider the loan that is most suitable to your financial needs. There is no one size that fits all. In simple and plain English, I would not recommend the Cash Rebate scheme unless you are stretching your financial capability to own the car. But the MOST important point in this post is that you will not know the actual finance cost for your car until the point of time when you sell it. I must also warn you that your financial stability is another important consideration as that may force you to sell your car premature of the loan tenure.
The two tools used in this article can help you to make a better decision - they may appear complex but once you start to plug different numbers for your possible scenarios, you will come to appreciate their usefulness. If you have read till this point, thank you for the attention … as the title has stated, this is a DEEP dive of the Cash Rebate scheme. If you come cross a new scheme which you would like me to analyze, drop me an email.