It’s that time of year again! I’ve had multiple car buying discussions with Relaxing Retirement members over the last two weeks, and it reminded me to share my thoughts on buying.
A statistic that every car dealer and manufacturer knows that most outsiders don’t is that a car is purchased every three years (on average) in every household.
Yet, in spite of this high level of frequency, purchasing a car remains one of the most stressful activities we all participate in.
I don’t know anyone who likes it which is why I get so many questions. I hate it as well, but it’s a necessary evil.
In my view, given the enormous cost of cars these days, it’s a very good idea to take the time to evaluate the most cost-effective way for you to purchase your cars both now and in the future.
With all the “financing” options you now have available to you, you really have to do your homework.
New vs. Pre-Owned
Before we begin with how you should pay for your next car, let’s talk briefly about buying a new car vs. pre-owned (formerly known as “used”).
In our home, we have typically purchased new cars. However, after test driving a new Land Cruiser SUV a couple years ago, the salesperson informed me the dealer wanted me to know that he also had the Lexus version of the same SUV.
The dealer had been driving it and it only had 1,200 miles on it. Most importantly, he would sell it to me at a deep discount.
After test driving that car and evaluating the numbers, I would have been a fool not to buy the Lexus. It’s a better car and the price reduction was too great to pass up.
This all worked out so well that we did the exact same thing with the same model four months later! However, this time, I had to do a little research to find one with very low mileage. I found another great option through another dealership.
I mention all of this because, depending on the model of car you want, buying a low mileage, pre-owned car may be a good option for you as well.
Appreciating vs. Depreciating Assets
Assuming for a moment that you’re considering the purchase of a “new” car, the first factor I believe you have to think about is purely financial.
Most of us have been conditioned over our lifetime to “own” everything. And, I believe that’s a worthy goal.
However, if you stop and think about that, what you want to own is “appreciating” assets. So, for example, owning your home makes the most sense for the overwhelming majority of individuals.
And, it makes sense because house values have traditionally appreciated throughout history, although not always as we all learned during the financial crisis in 2008-2009.
A car, on the other hand, is a “depreciating” asset. In fact, it depreciates rapidly, so you have to really question your desire to own it for “pride of ownership” reasons.
The exception to this, of course, is the individual who “really” likes cars and spends a lot of time working on them and maintaining them as a hobby. And, we have some Relaxing Retirement members who fall into this category.
Simply an “Expense”
If you really stop and think about it, purchasing and owning a car is simply another expense, much like many other expenses you have in your life.
It’s really not a very good “asset” from an ownership standpoint.
So, for the sake of our discussion, I consider and equate all money that goes into the purchase and ownership of a car as an “expense”. For example:
- buying the car for cash,
- making a down payment,
- making loan payments,
- making lease payments,
- paying sales and annual excise taxes, and
- repairs and maintenance
These are all “expenses” and have to be considered in your overall analysis of “how” you’re going to pay for your new car.
When you break it all down, it’s all a matter of “how much” you will pay and “when” you will pay it.
I recognize that most individuals give no thought whatsoever to how they’re going to buy their cars. However, I recommend having your own personal “long term” car buying strategy. And, that strategy should govern your car purchases.
Before we get into analyzing what would make the most economic sense for you, the question of buying vs. leasing a new car comes down to a few factors:
- your anticipated annual mileage, and
- the make and model of the car (and, in turn, its residual value)
Let’s start with mileage. If you know that you will be driving in excess of 12-15,000 miles per year, leasing gets pricey because they have to charge you up-front for excess mileage on the car.
Given this, leasing rarely makes sense if you’ll drive in excess of 15,000 miles per year.
On the flip side, if you don’t drive very much, leasing doesn’t make sense either. If you turn in a leased car after three years and you only drove it for 18,000 of the 36,000 miles you were allotted, the dealer got the better end of the deal.
Given this, the sweet spot for leasing is driving between 10-12,000 miles per year (and possibly 15,000 depending on the model).
Car Make and Model
Depending on the make and model car you wish to buy, two $40,000 cars can have monthly lease payments that are $150 per month different.
How can that be? Well, there are only three components to the monthly lease cost:
- price of the car,
- the leasing rate (interest rate), and
- the “residual value”. (The residual value is based on the price the leasing company believes they can sell the car for after you turn it in 3 or 4 years down the road)
Some cars have terrific residual values: Toyota (Lexus), Honda (Acura), to name a few. Others, unfortunately, do not.
So, for example, leasing a Toyota or Lexus that costs $40,000 is typically cheaper than leasing a Chevrolet or a Ford that have the same sticker price.
Now that we’ve laid this groundwork, we’re going to analyze the pros and cons of buying vs. leasing a new $40,000 car in the next issue.