After multiple car buying discussions with some of our Relaxing Retirement members over the last few weeks, I decided to share my car buying experiences and my thoughts on a car as an asset vs. an expense with you in the last issue.
(If you have not read it yet, I suggest taking a quick look at it before proceeding on.)
I concluded by promising to analyze the pros and cons of buying vs. leasing a new $40,000 car.
Let’s now dig into that….
For the sake of our discussion today, there are two important points to make:
- All money that you spend to purchase and maintain a car is an expense. So, for example, all of the following can fall into the “car expense” category:
- buying the car for cash,
- making a down payment,
- making loan payments,
- making lease payments,
- sales and annual excise taxes, and
- repairs and maintenance
- For the sake of our discussion today, I’m also going to assume that you’re going to purchase a new car as opposed to a “pre-owned” (used) car.
A great case can be made for purchasing a low-mileage, pre-owned car. As I shared with you, I purchased two SUVs with very low mileage a few years ago and got great deals. I wish I could tell you that I set out to do this. I did not. The first one fell into my lap and I was able to duplicate the process four months later with a little research.
For the sake of our comparison today, let’s stick with purchasing a new car.
As I mentioned in the last issue, I believe you should have a long-term car buying “strategy” which governs how you purchase cars, so let’s begin to analyze the pros and cons of each method of payment.
Before I begin, I don’t want you to overlook the last few words of the last sentence: “method of payment.” Essentially, that’s what we’re talking about here.
You’re still purchasing a car. The question is what “method of payment” works best for you.
If you buy your cars outright, or use car loans, let’s assume that you buy and keep them for approximately 8 years.
Except for extreme situations, purchasing a brand new car every 3 years with cash or using loans is never a good financial decision.
The reason for this is that cars depreciate massively in the first few years so you don’t walk away with very much. This is especially true if you trade them in to a dealer.
So, assuming you keep your car for 8 years, your cash outlay looks like the following:
- Year One: $40,000 is paid in cash to purchase the car, plus taxes, title, insurance, and registration fees. Maintenance costs are minimal.
- To free up this $40,000, you take the money out of an interest-bearing savings account. Or, you withdraw a larger amount from a tax-deferred account like an IRA and pay taxes before you can “net out” at $40,000 to pay for the car.
- Years Two through Four: your out-of-pocket costs for maintenance are minimal. (oil changes)
- Years Five through Eight: your out-of-pocket costs can be extensive as most significant car repairs and maintenance occur around 50,000 miles:
- new tires,
- exhaust system,
- timing belt,
- tune-up, etc.
- Year Nine: Begin the process all over again. Hopefully, if your car has good residual value, you can sell it for a reasonable sum of money to use toward the purchase of the new car.
However, you do have to take the time to sell it or take the easy way out and trade your vehicle in to the dealer. The downside of that, as you know, is that the dealer will not pay you what your car is worth on the retail market.
- Year One: You begin the process by purchasing a car using a lease. As you would if paying cash for the car, you still pay up-front for any taxes, title, insurance, and registration fees. (It makes no sense to pay a down payment toward the principal on a lease)
The only other cost when you pick up your car is the first month’s lease payment (approximately $550 per month for a $40,000 car depending on the make and model you want, and the residual value). And, just as if you bought the car outright, maintenance costs are minimal.
- As I mentioned in last week’s edition, two different $40,000 cars can have monthly lease costs which are $150 per month apart. The reason for this has to do with the residual value of the car (what the leasing company believes they can sell your car for in 3 or 4 years).
Some cars, like Honda (Acura) and Toyota (Lexus) for example, hold their value very well, so leasing them is much cheaper than leasing a Ford.
- Years Two and Three (or Four if a Four-Year Lease): Your out-of-pocket costs are:
- your $550 per month lease payment, and
- minimal maintenance costs (oil changes)
- Year Four (or Five if you have a Four-Year Lease): you begin the process all over again. You turn in your car to the dealer and begin leasing a new car just as you did three years ago.
What can make leasing an attractive option is that it “month-a-tizes” all of your car expenses: purchase and maintenance. When you buy cars outright for cash, (or use loans), your out-of-pocket expenses are more random.
When you lease, you pay no lump sum down payment. You just make a monthly payment until the end of the lease (3-4 years). At that time, you turn the car in and start all over again. There are three big advantages to this:
Outside of routine oil changes, you rarely pay for car repairs because cars typically don’t require repair in the first 3 years of ownership. And, you’re not inconvenienced waiting for your car to be serviced.
- You never have to place large sums of money (down payments, etc.) into a depreciating asset. Instead, your money can continue to earn interest or capital gains (potentially).
- You have a predictable monthly “car expense” payment which matches when most individuals receive their income, on a monthly
As you can see, the bottom line is to evaluate your driving habits, and the make and model of the car you wish to purchase first.
As I outlined last week, if you drive less than 15,000 miles per year (especially if less than 12,000 per year), and you plan to purchase a car with a high residual value, you really should do the math and considering leasing.
However, if you only drive 4,000 to 9,000 miles per year (as some of our Relaxing Retirement members do), then it makes more sense to buy outright and keep your car for many years. If you don’t drive very much, you end up giving your leased car back to the dealer at the end of your term with very little mileage so the dealer wins.
Either way, make your decision after carefully weighing the alternatives. Don’t allow yourself to be manipulated by a car salesman or the “manager” at the dealership.
Have a very definitive car buying strategy in mind and make your decision on your timetable, not theirs.
Happy car buying!!