The cost of financing

[DougEMG]

The bottom line is that one accumulates wealth by earning interest, not paying it. You can say that money doesn't matter all you like, but that doesn't make it true.

“Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it.”


― Albert Einstein

 

[ELMC]

Thanks for sharing your thoughts. I agree on a few things and disagree on a few others, and figured I'd share the highlights below.

At the time, I put together a good spreadsheet comparing the options, with present day value and future investments for the cash needed, the time required to save for it, and other factors (need to see if I can dig that up, but the spreadsheet may have gone the way of the dinosaurs). In all, I came the following conclusions:

1) the average break even point for financing would be about 30 years; about high 20 years compared to Value resorts, and Moderates were in the high 30 year mark. Deluxe were down the tubes (slightly above by a couple years), but I knew we'd never stay at a deluxe with regularity on cash.

I was surprised that given your background and after doing a pretty sophisticated financial analysis that you still decided to go ahead with a financed purchase, knowing what you knew.

2) the premium we pay for financing is the price for the intangible value we received from owning DVC by buying in early. This is where Ken's numbers shine. How much are the memories worth? His numbers provide a tangible cost for some to determine if the anticipated emotions are worth the price, or would delaying these memories (or collecting them elsewhere) be better.

Ok, now I'm less surprised. While I disagree with this type of thinking, I'm not about to say that you're wrong. Because who knows, maybe I'm the one that's wrong here. But my different thinking is that owning DVC (or even renting it for that matter) is not necessary to have wonderful family vacations at WDW. Sure the accommodations are fantastic, but there are many, many other ways to have a great stay at Disney without DVC. But at least you are accurately identifying the missing portion of the equation. Owning brings you happiness. Happiness comes at a cost.

For us, the memories we have made are worth the additional expense, already. Plus, we've garnered good will with friends and family that have vacationed with us or we have put up on their own vacation. In the end, the additional cost was a good value, and the value continues to mount.

See this is where you and I differ. You are generous and I am clearly a cheap (insert appropriate noun here). Family might be a different story, depending on how close we were, but I would not let friends stay in my DVC accommodations for free. I recently went on a trip with a good friend's family and even then I charged him a reasonable fee ($10pp for BLT points). So yeah, I gave him a bit of a discount, but I would not go so far as to let him stay for free, just as I would not pay his room charge if we stayed in a conventional hotel. Furthermore, I certainly would not do this if I still had a loan balance on my DVC contract. So while what you did was incredibly nice, it's the equivalent of taking out a loan to buy your friends dinner. Doesn't seem like a great financial move to me. That being said, your friends probably like you more than my friends like me.

Now, for my perspective on some comments...

...As for the future income stream, this was a point my DW and I discussed; who do we want to receive the financing money (if we did finance)? In the end, we decided giving the interest to Disney would serve our personal short and long-term interests as any additional cash in their pockets might help make them profitable and remain, instead of close shop and take our DVC with them. While I know we won't effect Disney on a grand scale (they aren't waiting with baited breath for our payments), if we had to pay someone interest, better to go to Disney (we thought).

This is not the first time I've read this type of thinking and I always find it fascinating. Disney does not care one iota about you or your family, so I am curious why you care about them. You make it sound like enlightened self interest (keep DVC in business so that you can continue to stay there) but in my opinion, that is not your responsibility or concern. Plenty of people get paid plenty of money to insure that happens. (Or sometimes they get fired because they're not insuring that it happens).

Sometimes it is better to sit on the cash and finance instead of pay cash for an item, and successful businesses do this all the time.

I agree with this with one very important caveat. You can't just sit on the cash, you need to be able to put it to work for you in a way that earns you more than what you would pay in finance charges. If you don't (and many, many people don't) then it's just a theoretical argument that does not apply.

As for the idea of over committing without being able to repay, I don't think many in this nation saw the recession on the horizon, despite ample warning. I would think most who finance are employed with a stable job, and they did (do) not anticipate being terminated. Also, I do not think DVD would let those in serious danger of over committing get financing; however if they do, the foreclosures are calculated into the loan's risk analysis.

But that's just the thing...people don't see this coming and they get destroyed when it happens. At some point you have to have a little foresight. Nobody anticipates losing their jobs, but if they were wise they would be prepared.

As for DVD not letting those in serious danger of over committing get financing, I disagree with that assessment. The two major criteria on being able to get financing with DVC are whether or not you can make the down payment and whether or not you have defaulted with DVD before. If the answers are yes and no respectively, you'll get your financing. Although like you said, that's where the 17.5% interest rate comes into play.

 

[Paging Tom Morrow]

All,

Financing is obviously a hot button issue for some, therefore I fully expected to get flamed for attempting to quantify it. So I wanted to say how much I appreciate how well this topic has been received and how tactful almost all of the responses are. It really makes me feel that the work I did to quantify the costs was worth it. Thanks again.

 

[JimMIA]

All,

Financing is obviously a hot button issue for some, therefore I fully expected to get flamed for attempting to quantify it. So I wanted to say how much I appreciate how well this topic has been received and how tactful almost all of the responses are.

Don't get too cocky! Five pages is just about the point where things start to deteriorate on hot topics!

It really makes me feel that the work I did to quantify the costs was worth it. Thanks again.

WELL worth it...good job and thank you.

Now if we could just get it moved to Purchasing DVC so that prospective purchasers would see it!

 

[Paging Tom Morrow]

Don't get too cocky! Five pages is just about the point where things start to deteriorate on hot topics! WELL worth it...good job and thank you.

LOL and I appreciate that.

Now if we could just get it moved to Purchasing DVC so that prospective purchasers would see it!

The part that annoys me is that I posted it initially in Purchasing DVC. One of the mods moved it. That's why I went back and added some tags to it, don't expect that they'll drive much traffic, but if it leads to one more prospective buyer becoming better informed, I'll feel like my time investment was worth it.

Now...how does everyone feel about the new RFID resort mugs?

 

[Dean]

Are you referring to only timeshares? For the most part, I disagree with this statement when it comes to housing, cars, and education. Why wouldn't you finance a house when many times you are earning equity while having a lower interest rate than what you should be earning on your savings accounts? I would NEVER buy a car outright if interest rates are lower than 5%! I'd rather pocket the $50k and go put it in my portfolio and I will do much better. For DVC, i agree that financing for the most part is an expensive decision...10% is really high...like a loan shark!

Timeshares, cars, anything consumer related. I don't feel as strongly about an appreciating asset like a house. I think anyone is fooling themselves if they finance to get a low interest rate or a car, furniture, etc. Companies do this for a reason and it's not to give people free money, it's to get people to buy when they wouldn't or buy more than they would have otherwise. That's my personal opinion.

 

[Apps]

Timeshares, cars, anything consumer related. I don't feel as strongly about an appreciating asset like a house. I think anyone is fooling themselves if they finance to get a low interest rate or a car, furniture, etc. Companies do this for a reason and it's not to give people free money, it's to get people to buy when they wouldn't or buy more than they would have otherwise. That's my personal opinion.

In theory, you should never ever ever buy a car outright even if you have the funds to do so. Why wouldn't you take a 2-3% interest rate you if you know you can earn better in your portfolio...makes no sense I'm not talking about people that overextend themselves. I'm saying rational people that can easily buy the car outright should choose to finance...there is almost an arbitrage situation at such low interest rates.

 

[Dean]

In theory, you should never ever ever buy a car outright even if you have the funds to do so. Why wouldn't you take a 2-3% interest rate you if you know you can earn better in your portfolio...makes no sense I'm not talking about people that overextend themselves. I'm saying rational people that can easily buy the car outright should choose to finance...there is almost an arbitrage situation at such low interest rates.

I don't want to get way off on this but I'll say that IMO the psychology of debt and financing is FAR more important than the math. It's like using a CC with no interest for 6 months or keeping a student loan that's low enough interest rate that you can earn more (maybe) than you're paying. IMO these are all bad choices. Plus, many people think they can afford something when they can't. IMO managing risk is even important than the interest and financing per se. One of the issues is that those low/no interest situations have major gotcha's built in and they can bite you at any time even if you do everything correct on your end. In the long run you're not going to beat them, not with low interest, not with FF miles, not with reward points. If you want to play with fire you run the risk of getting burned. Wish I'd known all of this 30 years ago.

 

[sweetdana]

In theory, you should never ever ever buy a car outright even if you have the funds to do so. Why wouldn't you take a 2-3% interest rate you if you know you can earn better in your portfolio...makes no sense I'm not talking about people that overextend themselves. I'm saying rational people that can easily buy the car outright should choose to finance...there is almost an arbitrage situation at such low interest rates.

There is always a discount for cash payment higher than the discounted interest rate. And a conservative rate of return of funds would be lower than your interest you would pay. Nearly always. A personal rate of return may be higher but certainly not at a no risk.

I wouldn't cause it is still more up pay 3% interest and make .5% profit then just pay for it.

 

[Apps]

I don't want to get way off on this but I'll say that IMO the psychology of debt and financing is FAR more important than the math. It's like using a CC with no interest for 6 months or keeping a student loan that's low enough interest rate that you can earn more (maybe) than you're paying. IMO these are all bad choices. Plus, many people think they can afford something when they can't. IMO managing risk is even important than the interest and financing per se. One of the issues is that those low/no interest situations have major gotcha's built in and they can bite you at any time even if you do everything correct on your end. In the long run you're not going to beat them, not with low interest, not with FF miles, not with reward points. If you want to play with fire you run the risk of getting burned. Wish I'd known all of this 30 years ago.

You are assuming that the buyer lacks discipline with their finances. I would think luxury buyers for the most part are very disciplined with their budgets and understand what they can afford. I do see your point of view on managing risk but whenever you take such a strong stance against financing...its a very very conservative view from a finance perspective and is not the optimal financial structure for a lot of people IMO.

 

[Apps]

There is always a discount for cash payment higher than the discounted interest rate. And a conservative rate of return of funds would be lower than your interest you would pay. Nearly always. A personal rate of return may be higher but certainly not at a no risk.

I wouldn't cause it is still more up pay 3% interest and make .5% profit then just pay for it.

My DVC purchase was completely separate from my financing decision...there was no cash discount to be had. My car purchase, my education, my house was the same...no cash discounts.

Everyone should make their financing decisions based on their expected return of their investments (its their personal risk profile that matters). I completely expect to return greater than 3% on my investments and my financing decision should reflect this expected return.

 

[Dean]

i've always wondered about this. it makes sense for most timeshares, but with DVC, the kiosks are already set up and the marketing machine is rolling anyway (most of the marketing costs seem pretty fixed). it seems like a low cost option to print a few brochures on the "classic" DVC resorts and offer them as an option to prospective buyers.

Yes, some of the overhead is built in but they're still competing with the new inventory. It does depend on how hard it will be to resell though as well as the spread.

You are assuming that the buyer lacks discipline with their finances. I would think luxury buyers for the most part are very disciplined with their budgets and understand what they can afford. I do see your point of view on managing risk but whenever you take such a strong stance against financing...its a very very conservative view from a finance perspective and is not the optimal financial structure for a lot of people IMO.

In some aspects yes and in some no. First, one tends to spend more by financing than paying cash. Just like with a CC where the numbers I've seen in the past suggest about 14% more than using cash IIRC. Everyone has to make their own decisions but I'd suggest that many people don't have the discipline that you hint is needed and that all of us would have less risk. My view may be conservative but the opposite approach is what's got many in the mess that's been going on the last few years. IMO all debt is bad, a mortgage is tolerable.

 

[ELMC]

Leveraging debt is a great concept, but the reason it works so well for corporations and less so for individuals is due to the sheer magnitude of the amount of money in play. When you're talking smaller amounts such as for cars, timeshares, etc. the risk is much greater. With larger amounts you can mitigate the risk by spreading money around, taking advantage of economies of scale, etc.

The problem with the discussion at hand is that Dean's point about the psychology of debt, while significant, cannot be measured in real numbers. Because of this, he has a hard time stacking it up against the theory of leveraging debt and actually getting anywhere. I think it is a mistake to project one's motivations and abilities on the public at large. There are plenty of wealthy people who are not very wise with their money. There are plenty of people who say they will invest the difference when they actually don't. There are plenty of people who charge things to get the 2% cash back and then let the balance sit on their cards for a year at 1% a month. There's a difference between textbook and reality at work here that I don't think gets accounted for nearly enough.

 

[Apps]

Leveraging debt is a great concept, but the reason it works so well for corporations and less so for individuals is due to the sheer magnitude of the amount of money in play. When you're talking smaller amounts such as for cars, timeshares, etc. the risk is much greater. With larger amounts you can mitigate the risk by spreading money around, taking advantage of economies of scale, etc.

The problem with the discussion at hand is that Dean's point about the psychology of debt, while significant, cannot be measured in real numbers. Because of this, he has a hard time stacking it up against the theory of leveraging debt and actually getting anywhere. I think it is a mistake to project one's motivations and abilities on the public at large. There are plenty of wealthy people who are not very wise with their money. There are plenty of people who say they will invest the difference when they actually don't. There are plenty of people who charge things to get the 2% cash back and then let the balance sit on their cards for a year at 1% a month. There's a difference between textbook and reality at work here that I don't think gets accounted for nearly enough.

For the most part I agree with this assessment however, financing through debt is just a tool. As with all tools, it can be misused but it can also be used very wisely to produce significant benefit to the user. Just because someone finances something doesn't mean they can't afford it...i don't think anyone should be lambasting someone just because they chose that path. Who knows...maybe their personal discount rate is around 12%

 

[Dean]

Leveraging debt is a great concept, but the reason it works so well for corporations and less so for individuals is due to the sheer magnitude of the amount of money in play. When you're talking smaller amounts such as for cars, timeshares, etc. the risk is much greater. With larger amounts you can mitigate the risk by spreading money around, taking advantage of economies of scale, etc.

The problem with the discussion at hand is that Dean's point about the psychology of debt, while significant, cannot be measured in real numbers. Because of this, he has a hard time stacking it up against the theory of leveraging debt and actually getting anywhere. I think it is a mistake to project one's motivations and abilities on the public at large. There are plenty of wealthy people who are not very wise with their money. There are plenty of people who say they will invest the difference when they actually don't. There are plenty of people who charge things to get the 2% cash back and then let the balance sit on their cards for a year at 1% a month. There's a difference between textbook and reality at work here that I don't think gets accounted for nearly enough.

The other reason that it works to a degree in big business is that there isn't personal risk. For small business (500 or less employees seems to be the cutoff), the same principles apply as for an individual.

Apps, it appears from your posts that you're of the opinion that for people to have things they are better off financing "if they can afford it" whatever that really is. I'm of the opinion that in the long run you'll have more stuff, more assets with less risk and less stress if you don't finance and you don't play games with money.

 

[z28wiz]

Timeshares, cars, anything consumer related. I don't feel as strongly about an appreciating asset like a house. I think anyone is fooling themselves if they finance to get a low interest rate or a car, furniture, etc. Companies do this for a reason and it's not to give people free money, it's to get people to buy when they wouldn't or buy more than they would have otherwise. That's my personal opinion.

Cars I have to disagree slightly. Ill finance when it's a zero percent deal or through my credit union at 1.79%. Why pull out the money from my brokerage or savings when it's earning a much higher rate of return?

I can make a clear example but its not the norm back in the early 2000's I bough into the google IPO and at the same time I was buying a brand new car I opted to finance the 30k car at zero percent and put the 30k into the IPO. The IPO in fact worked out very well.

Sent from my iPhone using DISBoards

 

[ELMC]

For the most part I agree with this assessment however, financing through debt is just a tool. As with all tools, it can be misused but it can also be used very wisely to produce significant benefit to the user. Just because someone finances something doesn't mean they can't afford it...i don't think anyone should be lambasting someone just because they chose that path. Who knows...maybe their personal discount rate is around 12%

I don't think anyone has been lambasted here, for what it's worth.

 

[ELMC]

Cars I have to disagree slightly. Ill finance when it's a zero percent deal or through my credit union at 1.79%. Why pull out the money from my brokerage or savings when it's earning a much higher rate of return?

Sent from my iPhone using DISBoards

I think Dean answered this question already...it's the psychology of debt. If your goal is to be debt free (and I happen to think that this is a very good goal) then it makes more sense to simply pay the car off regardless of whether or not you can earn a few extra points somewhere else. It's kind of funny, because I haven't heard anybody who is advocating leveraging debt talk about the possibility of a short term negative return, but we all know it happens. So in that case, you would have been better off paying for the car in cash. But regardless, I agree with Dean, there is a fine line between using debt as a tool and playing games with your money. There's certainly more to it than just the math.

 

[ELMC]

I can make a clear example but its not the norm back in the early 2000's I bough into the google IPO and at the same time I was buying a brand new car I opted to finance the 30k car at zero percent and put the 30k into the IPO. The IPO in fact worked out very well.

Sent from my iPhone using DISBoards

To say that this isn't the norm is the understatement of the century. Using the Google IPO as an example to support your position, even if you qualify your statement by saying it isn't the norm, is a bit ridiculous. I am sure many people have isolated anecdotes that support your position. However, to believe that one or two ideal situations suggest that it is not only reliable, but repeatable, is flawed thinking. Where you cite your example as evidence to support your theory, I would suggest that it is the exception that proves my rule.

You do bring up an interesting point, however, which is the option to finance at ZERO percent. This is a gray area, because 0% is obviously a hugely advantageous rate. However, it gets you into the habit of having personal debt, which is not beneficial. It also might encourage one to spend more than they can afford, although I'm not saying that's the case in your situation.

 

[z28wiz]

To say that this isn't the norm is the understatement of the century. Using the Google IPO as an example to support your position, even if you qualify your statement by saying it isn't the norm, is a bit ridiculous. I am sure many people have isolated anecdotes that support your position. However, to believe that one or two ideal situations suggest that it is not only reliable, but repeatable, is flawed thinking. Where you cite your example as evidence to support your theory, I would suggest that it is the exception that proves my rule.

You do bring up an interesting point, however, which is the option to finance at ZERO percent. This is a gray area, because 0% is obviously a hugely advantageous rate. However, it gets you into the habit of having personal debt, which is not beneficial. It also might encourage one to spend more than they can afford, although I'm not saying that's the case in your situation.

I do agree with the isolated anecodtes. I was just giving one example (which I guess was a poor one). But regardless, to each their own on how they spend or dont spend their money.

Anyways lets get back on topic of DVC financing which I do agree with Dean and yourself with regards to financing a timeshare.