Subvention, what is it and why?

Ever see those cheap finance rates advertised enticing you to buy goods and ever wondered ‘how do they do it? Or you might just think ‘who cares, Its cheap money’ right. From household goods to vehicles and equipment finance it’s a widely used practice, perfectly legal and designed to get you to buy NOW!

Given the Official Cash Rate ( OCR ) in NZ is currently at 5.25% means banks and finance companies simply can’t buy money for less than that plus a margin and they lend it out at rates based on risk, naturally mortgages secured by residential property with longer terms being the least risky have the cheapest rates and lending for business and on depreciating items like household goods, vehicles, plant and equipment with personal loans and in particular unsecured personal loans and credit cards being the higher risk hence the higher rates, all stands to reason.

So rates advertised at 0% and the likes of 1, 2 and 3 or even 5%, all being under the OCR at 5.25% … somethings up right!

Well yes it is and it’s called ‘subvention’.

Given NO bank or finance company will provide money at rates less than what they can get it for and will add a margin and lend it out based on risk as explained above, how then, can it be advertised and provided at those sub-vented rates?

We’ll there’s no secret wand you wave where you go ‘poof’ and the cost disappears … its being paid for and ultimately paid for by the consumer, in the price of the goods … let me explain.

Generalising here as it varies across the board depending on the product and rates but there’s a couple of things happening –

1. The interest cost is paid to the finance company by the retailer or manufacturer depending on arrangements

2. The cost is held in the price of the product sold to you.

So some manufacturers will provide incentives to retailers to sell volumes of product, a backhander if you will, and that can in part be to carry the cost of providing sub-vented finance offers, hence you’ll typically only see these offered on NEW product as it’s the manufacturers incentive to move product.

You’ll also, particularly on larger ticket items, see a limit on the term and amount so say on a $80k item you might need a 20% deposit and maximum 3 year term and you can have it at 2% for example, this limits the cost of finance and the amount the retailer or manufacturer has to pay to the finance company, there is a finite amount they can give away on it.

So some goods will be the same price no matter if you pay cash or take their finance offer as its the manufacturer paying it as an incentive so it may or may not be a cost for them as some will finance and some not so if you take their finance offer it will cost them or if you don’t it won’t so average across the board for their ‘limited time offer’ campaign being an incentive to move product will factor x amount of cost for them.

Others, on the other hand, will give you a choice, either take it at full retail of say $60k and 1% finance over 2 years with 30% deposit OR have a $5,000 discount and have it interest bearing at say 11.95% and the payments are about the same in fact $1.98 mth cheaper, I ran it through my quote programme to check … with $5,000 being the approximate cost of finance over 24 months at 1%.

So in the above example, would you take the 1% finance at $60k or are you better to take it at $55k @ 11.95% finance, both with a 30% deposit for comparison and given the payments are about the same, so here’s the scoop –

• Having it interest bearing provides a tax deduction for interest for business purposes

• If in a year’s time you either write it if off, your needs change or you see the latest thing and must have and trade it up to a new one, at $60k and 1% you’ve paid ALL the interest up front regardless but at $55k and 11.95% you only get charged for the interest that you use … so it’s less.

• The GST paid is less at $55k

• If you trade it for $45k in a year’s time its cost you $10k in depreciation if you buy it at $55k v’s $15k if you buy it at $60k, that looks like less to me.

So in reality, where an offer is provided and the price is the same if you take the sub-vented finance or not, 1% is cheap money if the payments are affordable as they will be on a shorter term. If on the other hand you can negotiate a price for the item and have it interest bearing, then depending on the deal, you’re typically better off for the reasons given above and can make the payments cheaper over say 5 years AND you only get charged for the interest you use. Take it at full retail and a sub-vented interest rate and the finance company is paid ALL the interest no matter if you pay it back early or not … and they don’t give it back if you do.

So happy days for the subvention if it works for you but checking in on the deal can be very much worth your while as there can be benefits in NOT taking that offer as it stands … and its simply an incentive to get you to buy now which is totally righteous in itself.

So everything on a case by case basis, tailoring finance to suit is the domain of Infinance so if you have any questions around that just give us a holler and we’ll sort it for you.