Buying vs Leasing a Car
Although it might not be necessary for everyone to own a car, facts are facts; most of us do. Owning a car means paying out a lot of money to get one, and then more money to keep it running.
Cars are expensive. Even if you're not looking for anything fancy, you'll pay a lot of money for a new car. If you're going to buy a car, there are several ways to do it. You can walk into the dealership, plunk down $26,435 on the counter, and drive off in your brand spankin' new Explorer. Yeah, right. Or, if you're like most people, you can finance your car.
Financing Your Car
Most dealerships offer car financing. However, unless you get a special deal like the 0 percent financing offered a few years back to boost lagging car sales after the 9/11 attacks, dealer financing normally costs at least one or two percentage points more than a bank or credit union, although dealers have been making an effort to compete, and, in some cases, are able to.
Stay away from finance companies that offer guaranteed, same-day loans and other ploys to get your business. The rates these companies give you are virtually always higher than what you'd get from a bank or credit union. Most of these companies cater to people with bad credit, who would have trouble getting a bank loan.
Also, if the car dealers control your loan, they could try to talk you into buying a more expensive car than you would normally, by assuring you that they'll give you the extra money you need to cover it. Even if a dealer offers what sounds like a terrific financing deal, make sure you consider all the facts and know what the actual cost of the car will be once the financing kicks in. And don't let a dealer persuade you that it's okay to drive the car off the lot before the financing is approved. Car dealers are out to make money one way or another, whether it's from the cost of the car or through finance charges.
Generally, a better way to finance your car is to get a loan from a bank or credit union. You'll probably get a lower interest rate and you won't be at the mercy of the dealership.In fact, if you walk into a car dealership with a pre-approved car loan, it puts you in a great position. Here's why:
- You know how much money you have, and you buy within that amount.
- The car salesperson knows you're serious about buying, and he'll do everything he can to make sure you buy from him.
- You're not at the mercy of the dealership to get your loan. Instead, the dealership has to work on your terms.
Shop around for interest rates when you're looking for a car loan. Traditionally, credit unions offer the best rates on car loans—more than 11/2 percent less on average than a bank loan. That difference can save you a lot of money over the length of the loan.
Consider the following when getting a car loan:
- Instead of an installment loan, go for a simple interest loan, which lets you pay interest only on the remaining amount of your loan. The bank will figure out the total interest on your loan and set up a plan where you'll pay the same amount each month for the life of your loan. That's better than a front-end installment loan, which requires you to pay interest each month on the full amount of the loan.
- Put down as much money as you can. The more you put down toward your car, the lower your interest rate will probably be. Plus, you'll be financing less, thereby paying less interest overall.
Some dealers offer new cars for no money down. The catch there, however, is that if for some reason you end up keeping the car for only a short time, you could find yourself in big trouble when you go to sell it. The value of a car depreciates dramatically in its first year. If you made no down payment, you actually could end up owing more than the car is worth at the end of a year or so.
- Use rebates (money the car manufacturer offers you as an incentive to buy its cars) to make your down payment bigger. If you're offered a rebate on a new car, by all means take advantage of it. But don't buy a more expensive car just because you get a rebate.
Dollars and Cents
Don't put extra money toward a 9 percent car loan if you have an 18 percent credit card bill outstanding. The extra money will go a lot further if you use it to pay off the Visa bill.
- Take the shortest loan term you can manage. Don't pay back a loan over five years if you can do it in three. Even though your monthly payment will be smaller on the five-year loan, you'll be paying interest for a longer time and will end up paying more in the long run.
- Pay off your loan early if you can. Some lenders let you pay off a loan early, but others will penalize you. Be sure to find out about that before you sign on for the loan. Don't take out a loan that won't permit you to pay it off early.
- The interest you pay on a car loan is not tax-deductible, but the interest on a home equity loan is. If you own a home and need to borrow money for a car, look into getting a home equity loan to use instead of a car loan.
Leasing, the practice of paying a specified amount of money for a specified time for the use of a product, has been gaining in popularity over the past several years, and many people swear by it. It's a little tricky, though, because determining whether it's a better deal than buying is difficult. Basically, when you lease a car, you pay for the estimated depreciation that's occurring to the car while you're driving it. You pay only for the part of the car's value that you use, plus interest.
When you begin a lease agreement, the dealer estimates what the car's residual value will be at the end of your lease. If you have a closed-end lease, you simply come to the end of your lease agreement and turn in your car.
Show Me the Money
Leasing is the practice of paying a specified amount of money over a specified time for the use of a product.
Residual value is what your car will be worth at the end of the lease. It's what it would cost to buy the car, used, at that time.
If you have an open-end lease, you may not be able to walk away at the end of the lease, you may owe the difference between the residual value of the car and the actual market value at the end of the lease. This might be the way to go, as long as the street value of the car has remained above the residual value determined by the dealer. You would then be buying the car for less than you could anywhere else. If the dealer overestimated the car's residual value, however, you'd be paying more for it than you would somewhere else. See what we mean about leasing being a tricky business?
There are some good reasons to lease a car, but there are some good reasons not to, as well. One major consideration is that you'll never pay less overall for leasing than you do for buying, because you'll always be paying, but never own the car. It's sort of like renting a car for an extended period of time.
Still, many people like leasing for one reason or another, such as those who have a special need for a particular vehicle for a limited amount of time.
Before you decide to lease, consider some of the pros and cons.
More on: Family Finances
Excerpted from The Complete Idiot's Guide to Personal Finance in your 20s and 30s © 2005 by Susan Shelly and Sarah Young Fisher. All rights reserved including the right of reproduction in whole or in part in any form. Used by arrangement with Alpha Books, a member of Penguin Group (USA) Inc.
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