Overtrade for a New Ride?

I have receive this request from LIM Y W for advice:

"Hi, need your help to understand the relationship between overtrade, cash rebates etc in determining if its useful to buy a car. My stituation is this

- have a car coming to 5 years
- outstanding loan is still around $50k in June. unlikely to get a trade in to full redemption value at normal circumstance.

hence,
- would it be useful for me to ask for an overtrade value to offset this process of selling off my old car?
- if I combine this with the cash rebate, would it make sense?
- for cash flow, I would also look at loans 7 years or above, and maybe even 100%

so far, current car is the longest I have held onto a car. looking to selling cos am keen on other models and people have said that if I want to sell, the best time is to do so before its 5th year. If I get the right car, I would look to holding onto it for more than 3 years, maybe even 5.

any advice?"

Let me first explain the Overtrade practice by dealers. It is introduced when the MAS regulation for a motor loan limit of up to 70% of the car price was in effect. A typical scenario was that the motorist wanted to trade in his old ride for a new one but the value of his old ride was not sufficient to match the downpayment.

Example:
Value of old ride = $10,000 (market value - outstanding loan balance)
Price of new ride = $70,000
Required downpayment = 30% x $70,000 = $21,000
Maximum loan amount = 70% x $70,000 = $49,000
Shortfall = $21,000 - $10,000 = $11,000

Overtrade amount = OT
In order to meet maximum 70% loan amount, 30% x (70,000 + OT) = 10,000 + OT
Solving the equation, OT = 15,715
Inflated price of new ride = $85,715
New downpayment = 30% x $85,715 = $25,715
Maximum loan amount = 70% x $85,715 = $60,000

Thus, the trade-in value for the old ride was increased to $25,715. The difference was that the buyer had to sign up a new motor loan of $60,000 instead of $49,000; no additional cash outlay was required.

Since MAS had relaxed the rule to allow for 100% loan, the Overtrade scheme has been used to help motorists with their current ride in negative equity. What is negative equity? See my post on "When is your Ride Breaking-Even?". The overtrade scheme is essentially carrying over the outstanding loan balance after deducting the market value of the old ride to the loan of the new ride. Thus, it is a cashflow tool but it burdens the borrower with a bigger loan.

What about Cash Rebate? See my post on "A Deep Dive into the Cash Rebate scheme". Cash rebate is essentially getting cash upfront for a loan with a higher interest rate; the cash is either used to lower the purchase price or returned to the buyer.

Back to Lim's request:
1. What is the objective of getting a new ride?
Lim: "am keen on getting other models"
Lim: "If I get the right car, I would look to holding it for more than 3 years, maybe even 5."

How do you define "right car"? If your criterion is fashionable model, then all cars will not be right after newer models are out. My definition of a right car is one that takes my passengers and I to our destinations safely with a reasonable known running cost.

In my opinion, it is a very expensive lifestyle to keep upgrading to a newer model every few years. It is fine if you can afford it but using the two schemes to facilitate that will create a long-term strain on your financial health.

2. When is the best time to sell your old ride?
Cars are made to last for more than 10 years and we should strive to utilize them for the full 10 years lifespan (limited by the COE expiry). You can use the "Financial Cost of Ownership Tool" to analyze the annual depreciation. Although your old ride has higher PARF rebate up to age of five years, you have to consider the rapid depreciation in the earlier years too. You can see clearly that the depreciation rate is decreasing over time i.e. you incur less to run your ride in the later years.

I can think of some good reasons to change your old ride:
a. Heavy fuel consumption, coupled by need to drive extensively for your job - consider green cars such as the hybrid or CNG model.
b. Need major parts replacement (eg. gear box).
c. Family size has outgrown current capacity.
d. Road worthiness is a concern.

Showroom cars are always appealing and you should always think carefully over the decision for a new ride. Consider the stakeholders in the motor business:
1. Government - new car sales will help to increase our budget surplus with the "income" from COE quota premium and vehicle taxes.
2. Dealers - they will go out of business if there is no car buyer.
3. Banks - they will go out of business if there is no borrower.

Don't step into a showroom and you will avoid being tempted to change your ride. Hope this helps.