I Like Cars. I Hate Buying Them.
When faced with the reality that our vehicles will not run forever and that someday (unfortunately for me sooner than later) we will have to consider a new car. The question soon becomes – Do I lease it? Do I finance it? Or do I buy in cash?
Before diving in, I think it’s only fair to establish my credibility by saying that I come from a car dealer family. My great grandfather used to assemble Ford Model T’s at the train station in his town and drive them back to the lot to sell. He was one of the earlier Ford dealers in Texas. After him, my father and grandfather both spent their entire careers working at this dealership. Me? I grew up on the car lot but ended up disappointing the family by choosing to be a financial advisor. Kidding...kind of.
When deciding how to proceed the answer is everyone’s favorite: it depends. For most people, and in my opinion, I believe that paying cash for a car you can afford is best. However, that may not always be the case; you’ll have to evaluate your own goals, preferences, and (obviously) finances before deciding.
Should I lease a car?
The key to a lease is that you do not own the car you drive. It's a long-term rental. Effectively, you are paying for the dealer's analysis of the depreciation of the vehicle over your lease term plus interest for the dealership “lending” you the car. Here are 3 things to consider:
How often do you need a new car?
If you don’t envision owning a car beyond its factory warranty, you might consider leasing instead of owning. In either case, you are paying for depreciation in the costliest years (depreciation is highest in the first few years of vehicle ownership). Leasing just locks in a depreciation cost plus interest.
How dependable do you need your car to be?
More than likely, you’re leasing a newer car which comes with less debilitating repairs to pay for out of pocket. Almost all repairs (barring any kind of wreck) will be covered under warranty for the duration of the lease. If finding a mechanic you can trust is too stressful and you do not want the unknown of a service bill, leasing is a good option.
How predictable is your annual mileage?
A major drawback to leases is the mileage limits placed on you each year. When signing a lease, you agree on an annual mileage limit. Going over that limit can be costly – in most cases it can be between 15 – 25 cents per mile.
Should I finance a car?
Growing up, I assumed everyone had a car payment. Most customers financed their cars, and a car payment was part of the monthly budget. I’ve since learned that does not have to be true. In fact, many people do not have car payments, but they may have had to make sacrifices elsewhere. For all of the following questions, I assume the individual makes a reasonable living and that a car purchase is materially significant.
How long will you own this car?
If you plan on owning this car for many years even beyond the term of your loan, then financing a car may be an acceptable option. The goal will be to drive the car for a considerable amount of time beyond your loan term to minimize the number of years paying interest.
How new/nice a car do you need?
If you want a brand-new car or high end car, then you may be forced into financing a vehicle. Obviously purchasing a car outright is a serious financial undertaking which may seem insurmountable had you not been planning for it. If lease lifestyle does not work for you, then financing is a fine choice albeit expensive unless you keep the car for a long time.
Do you have an investment with a guaranteed return above 7%?
I pose this question here because many people come with rhetoric that states that money spent on a car could be invested in the stock market. While true, let's make sure we're comparing apples to apples. The time horizon on most car loans is 5 years or less. That means we should be thinking about stock market investment returns in 5 years or less. Absolutely, the stock market could be up greater than your interest rate on a car loan (average auto loan 7.03% for new cars as of this writing), but there is also a very real possibility that it could not. Equities come with much higher risk, volatility, and uncertainty. Your annual interest rate does not. To avoid a car payment by paying in cash you in essence earn a return of whatever your loan interest rate would be. I’d opt for a return of 7% if I can.
Should I pay in cash?
Strictly from a financial perspective, paying cash for a slightly used, historically reliable car and driving it for 10+ years make the most sense. every. single. time. Anyone trying to tell you otherwise is trying to sell you something. However, our preferences play a huge role in car buying decisions.
Do you have enough cash?
If you do not have the cash to buy the car you want, you will have to keep your current car, settle for something less than what you want, or finance. Easy question; easy answer. A more nuanced question would be: do you have enough cash so that this purchase would not be financially ruinous? I am unlikely to recommend sinking your entire net worth into a new vehicle just because you want a new car.
Can you settle for less?
If cars do not matter that much to you, you have a good, trusted mechanic, and the hassle of the car buying experience is overwhelming, figure out what you want to pay and go find a car that fits your needs.
How much time do you have?
If time is not critical for your next car purchase, you can get the best of both worlds by saving methodically and getting a car that you want while avoiding paying interest.
You should know how you’d like to purchase a vehicle before you walk into any dealership. If not, they will skillfully maneuver you toward whatever helps them make the most money – it will sound great to you, but I promise, if you walk in knowing how you want to buy, you’re better off.
If you’re facing an upcoming car purchase and want to discuss the financial ramifications, please feel free to reach out to me - my friends already do.
Believe it or not, I’ve tried all 3, and the one that brings the most peace is buying an older car in cash while saving for my next car with a goal in mind. Unfortunately for me, the allure of changing cars regularly is too enticing. I’m best off if I keep buying hoopties.
