In light of the economic impact of coronavirus and the general desperation of automakers to sell cars, several brands are offering special financing programs such as zero percent loans and/or deferred payment programs. Kia’s version is a good example of how these programs can be both possibly a bargain and financially dangerous.
Kia is offering up to 120 days deferred payments and up to 75 months at zero percent APR on specific models such as the 2020 Optima (Hybrid and PHEV), 2020 Sorento, 2019 Niro (EV and PHEV), Cadenza, Stinger, and K900. Other models get zero-percent financing for up to 66 months.
The key piece of fine print in the ad says the following “Payment schedule deferral is optional and will lengthen your contract term.” Clearly you don’t have to put off your payments if you don’t want to, but if you do and you were to finance a car for 75 months, that would mean your total loan would be 79 months, or about six-and-a-half years.
This is financially risky on a few fronts. First, long loan terms obviously mean that it will take a lot longer for the balance to be paid off but that also means that the rate of depreciation on your car could be faster than you are paying down your loan, which increases your risk of being underwater. The deferred payment plan exacerbates this risk because most cars incur the most dramatic depreciation in the first year. So, in this case, your brand new Kia is losing value fast yet no payments are being made for the first four months to chip away at the principal loan balance.
Let’s look the Optima SX, which has an MSRP of about $32,000. One-year-old examples with reasonable miles retail for around $21,000 - $23,000. That likely means the trade-in values on these were somewhere between $18,000 - $21,000. That Optima is losing about $12,000 worth of value within one year.
In fairness, buyers probably don’t pay sticker price for a new Optima. But even if you got a price of $28,000 on a $32,000 car, depending on your local tax rate your transaction price is probably closer to or above $30,000, so you are still looking at at least $10,000 in drop between the total cost and the residual within the first year.
Now suppose a buyer financed that Optima at $30,000 all-inclusive of tax and fees and did the 75 months at 0 percent and deferred payments for the first four months. Their payments would be $400 per month. But within that first year, they would have only paid $3,200 towards the principal, while the value dropped by at least $10,000. Even in the second year, with a total of 20 months of payments, the buyer has only paid down the car by $8,000 and it has continued to depreciate.
Obviously, this depreciation risk with deferred payments and a super long loan can be mitigated with a substantial down payment that would establish some equity in the car and keep buyers ahead of the curve regarding the car’s loan balance versus the value of the car. However, a lot of buyers are often financing 100 percent of the purchase, or, even worse, rolling over negative equity into a new car loan.
I’ve covered before that the most expensive car buying mistake can be buying a car and trading it in too early, but these long loan programs combined with deferred payment programs make the risk even worse.
There is nothing wrong with taking a loan with no interest, and the deferred payments can give some buyers breathing room if their current income situation has taken a hit. But remember that just because something sounds like a good solution, doesn’t mean it is.