A New Lease on Life (of a car)

Along with housing, our next largest purchase is generally on transportation, be it a car, a truck or something in between.

Whether you buy or lease primarily depends on how long you plan to keep the vehicle and how much you plan to drive it.

There are basically three ways to own a car. Usually, the least expensive way to own a car is to negotiate the best price, pay for it all at once, and drive it until its repair costs are higher than the eventual value of the car. Leasing is generally the most expensive way to “own” a car, but for the added cost you get to drive a new car every few years. Borrowing to purchase a car usually works out to cost something in between these two.

When to Buy

If you typically buy a car infrequently and hold it for long periods of time (typically greater than four years), or if you drive more than 15,000 miles per year, your best decision is usually to either pay cash or finance it. The deciding factor is the cost of financing. Car manufacturers often “buy down” interest rates on loans in order to make it easier for buyers to make these large purchases so the car companies can sell more units. If the vehicle you’re considering isn’t one of the more popular models, or is close to or past its model year, you may get such a favorable interest rate on a loan that paying over time is a better decision than paying for the entire purchase price all at once.

What would be a favorable interest rate? Generally, any rate that is lower than what you’re planning to receive on money invested over the long-term. So, if your investments are projected to return 5% after-tax and the interest rate on a car loan is quoted at 5.5%, then you’re better off paying cash for the car. If the interest rate offered is 4% you would be better off financing the purchase.

When to Lease

Leasing can sound complicated because leasing companies use terms and numbers that are specific to their industry and, to be honest, a bit opaque by design. We are always happy to help you with this decision. In a car lease, you are basically financing part of the price as a purchase over time, and part as an interest only loan.

An example would be best to help describe the transaction. Let’s say you’re in the market for a new sedan, like a BMW 530i (we aren’t partial to BMW’s, it is just an example we have at hand). Here are the details:

  • The list price of the car is $56,495.
  • BMW will lease you that car for $3,500 down (not including license), plus a $925 acquisition fee and $519 per month for 36 months. If we assume a 9% sales tax, the total monthly payment would be $566 per month.
  • At the end of the 36 months, as long as you’ve taken good care of the car and haven’t exceeded 30,000 miles, you can return it to the car dealer and walk away without any additional costs.
  • If you would rather buy the car at the end of the lease, BMW will sell it to you at the preset price of $39,841.

How much is it costing you to lease the car? Your total monthly payments would be $20,376 and the cost of the car is reduced during that time period by $13,154 (the purchase price of $56,495 minus the $3,500 down, minus $39,841). That works out to a finance rate of about 4.8%.

The difference can be large when comparing a lease to a purchase. Let’s say that instead of leasing the BMW you buy it, financing the purchase over five years. Assuming you could get the same 4.8% interest rate, your payments would be about twice as high at $1,156 per month (which includes sales tax on the entire purchase price instead of just the monthly payments). After three years of making those payments, you would owe about $35,165. When compared to the lease, you would have equity in the car of $4,676 (BMW’s estimated value of $39,841 minus your remaining loan amount of $35,165).

Three additional items to note:

  • An advantage of leasing is paying the sales tax over time without financing it because you pay it each month based on the lease payment amount. Plus, if you don’t buy the car at the end of the lease, you never pay sales tax on the full value of the car as you would if you purchase it.
  • As in purchasing a car outright, there are a number of negotiation points in a car lease. These include the purchase price of the car, the amount you put down, and sometimes the fees. At the end of lease, you can often negotiate the price of the car again if you decide to purchase it.
  • If you drive a lot, generally more than 15,000 miles per year, leasing doesn’t usually make sense because of the way the lease calculation works and the effect high mileage can have on used cars.

Car Pricing

A point of frustration for most thrifty car buyers is figuring out how much to pay for the car we want. We can get the Manufacturer’s Suggested Retail Price (MSRP) easily, but that is generally just a starting point for the negotiation.

Being armed with more information is always good, and there is a wealth of information on the internet, starting with Edmunds.com. Here you can find MSRP and the dealer’s invoice price from the factory. Although the invoice isn’t necessarily what the dealer paid for the car it can be another valuable piece of information (dealers often have factory incentives that further reduce their costs for vehicles they sell).

Knowing the value of your car is also important if you want to trade it in. To find that, nadaguides.com (for NADA Guides) or kbb.com (for Kelley Blue Book) can be helpful.

Finally, if you want some general tips on how to negotiate a car purchase, this article is interesting, and a little entertaining: https://www.edmunds.com/car-buying/confessions-of-...

Again, we’re always happy to help in any way that we can, and we have been known to help our clients negotiate the purchase of a car. Please do not hesitate to ask us.