Sunday, June 15, 2008

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.

- 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.

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.

Related posts: Cost of Ownership, When is your Ride Breaking-Even?, Costly Frequent Car Refresh?, Financial Cost of Ownership for Used Car


Anonymous said...

tks for giving your perspective. I am in the same situation as this person. current monthly mortgage is 900+, and my car is coming to its 5th year in Dec. My car paper value is at $38k. a dealer has put together a package of both rebate and overtrade such that my monthly is lower at 900 over 7 years although I still need to come up with cash of $5k. from my perspective, it seems to make sense: I pay less per month, I have a shorter loan period (7 yrs vs 10yrs currently), and I get a new car. in this instance, would you agree that its OK?

skxly said...

See my response at this post.

Anonymous said...

Hi,just want to tell u that i appreciate your insight on whether one should change one's car.I have been driving since i was 21 paying for my own ride and have made a few blunders with my previous cars and had no one to turn to for advice.If there was such a posting then,i would have been greatly enlightened and would have saved a substantial amount of money.Anyway better late than never.Thankyou for taking the trouble to analyze and teach.The world could certainly do with more people like you.=))

skxly said...

Thanks for your kind words. I am glad that the post has benefitted my fellow motorists.

Confused SG Driver said...

As mentioned by many other visitors to your blog, the information you have presented here is truly useful and concise!

And like many people who visit your blog, I'm currently looking to upgrade my present car. However, I'm not that great with detailed numbers and am perhaps not very adept at translating the full meaning and implications of the data which were calculated after entering them into your most detailed "used car" spreadsheet. As such, my present situation is like so:

1)I currently drive a second hand Mazda 3. I purchased this last year October (10/2009) at a price of $34k. My current monthly installment is $550 and my current mileage is approximately 79k. It was originally registered in 2005 october.

2)I understand that it sounds silly to sell my present car being that I have only bought it less than a year ago.However, I made the mistake of purchasing a '05 mazda 3 which has a appalling Fuel consumption of 10.4km/l, at best. I am in sales and drive alot, having to pump approximately 5 to 6 full tanks of 92 grade petrol at SPC for a cost of approx $70 to $80 per tank PER MONTH.

3)I am looking at a second hand 2009 Toyota Allion which has a highly praised Fuel consumption of around 15 to 17km/l.
A dealer has offered me a trade:To sell my Mazda 3 at $28k(being car paper value of 21k), and a buy of their second hand '09 Allion with a low mileage of less than 20k at a pice of $60k. I am also may be looking at a over trade of around $5k to help to settle all the administrative fees and requirements

So my question would be:

1) Would it be a good time to buy and sell right now(being that all cars are now inflated due to the high COE bidding)? Or should I wait further?

and If I waited further would I lose more money due to petrol costs (or touch wood maintainence costs) of the high fuel consuming Mazda 3?

And also, should I believe the car agent who tells me that ,should I choose to wait till October, they would only be able to export it and thus only be able to offer me much less for it?


Should I buy the Allion in a moment of insanity, how long would I have to drive it before selling it in the future?Would it also make it doubly hard on me to sell it then being that I bought it at a high COE value peroid?

Thank You very much,
Confused SG Driver.

skxly said...

Please see my response at this post Overtrade to Improve Mileage.