(Guest post by Vince Beretta)
Yep, you read that right – you can build net-worth with your car.
If you own a home and are in an equity position, you should consider the differences between making a 0% car payment and using your Home Equity Line of Credit (HELOC) for your next car purchase.
I will be the first guy to tell you that the ‘car business’ wants you to buy with payments – and for some people that will make the most sense. However, a disciplined plan can be very beneficial.
You’ve seen the ads, “0% for up to 84 Months” or “$8,500 Cash Incentive.” Terms of these deals vary from 36 to 84 months and cash incentives from $1,500 to $15,000 or more. But how will that work for you?
Let’s take, for example, 0% over 84 months and a Cash Incentive of $8,500.
The all-in purchase price for the 0% deal is $38,500 and the all-in Cash Deal is $30,000. The payment for 0% over 84 months is $458.33, while the monthly interest on an HELOC increase of $30,000 is $68.75, which produces $389.58 in additional monthly cash flow. Now, if you directed that monthly cash flow to an RRSP every month, your combined interest and RRSP contribution would be the same as your 84 months 0% payment, $458.33! If you’re like me, wouldn’t you rather pay that $458.33 to yourself?
Over 84 months, your capital RRSP contribution is $37,400, and with a modest return it would grow by $4,500, so your tax savings will range from $11,500 (@ 35%) to $16,365 (@50%). At the end of 84 months, you have increased your net worth by $53,350 – $58,265 depending on your rate of tax. If your interest rate goes up (from 2.75 to 3.75%), your net worth outlook decreases to $49,720 – $54,810.
BUT you have to be very disciplined using your cash flow and putting it away combined with living within your means. Why not set up an automatic withdrawal/deposit into your RRSP? This makes sure you are not incurring credit card interest – if so, use your cash flow temporarily to get this under control.
Second, despite self-financing your car over 84 months, it WILL depreciate. If you were to write off your car you should protect your HELOC by limiting the depreciation of your vehicle to “your loan balance” vs. the insurance settlement.
Let’s say you bought using the 0% deal and after 40 months you get into an accident and your car is deemed a total loss. You would still owe $20,000 on the loan, but the market value for your car (the value your insurance company will use to settle your claim) is $11,700. Well, you just lost $8,300 of after-tax money. The same would be true if you self-financed using your HELOC. So the second point above is – despite self-financing and in the event of a write-off, with the adequate protection you would “repay” your HELOC $20,000 vs. $11,300 and you would start the process all over again upon replacing your car. These protection products are known as Total Loss Protection or GAP (Guaranteed Asset Protection) and you are basically protecting your home equity from negative equity & depreciation inherent in automobiles.
If you did this 7 times over your life (50 years), with compounding interest you would drive a new car every 7 years and have over $425,000 in your RRSP/Investments. Hey, your retirement outlook just got better – so go buy a car.