"We know you need the truck right now and we're saving money for a few years to buy it."
Many municipal council members would view that as a sound financial decision even if it means delaying for a few years the purchase of a newer, safer truck.
But not so fast.
Choosing to save may actually be a more expensive option and delay the purchase of a needed apparatus for the community.
The cost of borrowing
The decision to save is usually based on avoiding the costs of borrowing, or paying interest. And while interest can add up to 25 percent onto the cost of a new truck, the choice to save is not free. Sometimes it can exceed the cost of borrowing to buy now.
The reason is the cost of lost buying power. When a department chooses to save, it begins to chase a moving target — the ever-increasing cost of a fire truck.
However, many council members do not factor into their decision the expense of a higher-priced fire truck purchased a few years in the future.
As a fire truck increases in price by 3 percent, 4 percent or 5 percent or more each year, the cost of lost buying power soon becomes profound. For a $300,000 truck, inflation of 3 percent will increase the cost by $50,000 in just five years. If truck inflation is 5 percent, the truck will reach this price in three years.
By comparison, financing cost for a three-year lease would be about $19,000 and about $29,000 for a five-year lease.
That means fire departments can get a truck now and pay a final cost of $319,000 rather than waiting three years and paying $350,000.
Cost vs cost
Why does it actually save money to pay interest rather wait? There are a few reasons that impact the math of this decision.
First, fire truck inflation rates are currently much higher than interest rates. So, the impact of interest rates is less than the impact of inflation.
Interest rates have been at historical lows since 2008 and the Federal Reserve has recently indicated its preference to maintain low rates until at least late 2014 to jump-start a slow recovery.
And borrowing is getting easier.
Banks have emerged from a position of being reluctant to lend in 2009 and 2010 to actively seeking new loans today. Banks have a lot of cash to lend and want to lend. Creditworthy municipalities will encounter no troubles in borrowing money.
Truck inflation is expected to rise given the dependence on inflationary materials like plastics, copper, and steel. As the world economy grows from its current recession, demand will cause prices of these materials to increase. Also, technology advances are adding substantial costs to the price of a new truck.
Second, interest is paid on a declining balance each year. Inflation is added to an increasing amount each year. This compounding has a dramatic effect on the final numbers.
So, given all this information, does waiting to purchase ever make sense as the best financial choice?
It does in a few situations.
First, when the truck is being purchased within one year and the department will budget enough to pay for the truck in the next budget. The savings difference will be so small that the effort of financing will match or exceed the savings in the truck price.
The second situation is when a department has a disciplined annual savings reserved for a future truck purchase. This is commonly called a reserve fund and the department is funding a sufficient amount each year to be financially ready for the future truck purchase.
So, if a council's choice is to begin to save for a truck you need right now, it may be financially savvy and safety minded to run the numbers to see if buying and financing will save money.
About the author
John R. Hill is an apparatus budgeting consultant for First Bankers, which helps fire departments avoid common financial mistakes that are made in the apparatus purchasing process. John also writes a weekly Web site column on FireFinanceGuy.com.
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