Buying vs. Leasing a New Vehicle – Part One – 3 Important Points to Remember
Having a vehicle is a critical part of life for most people, necessary for family or work or both. Especially in the Maritimes where public transportation options are relatively minimal. So figuring out how to pay for this expensive infrastructure is something most of us have to consider.
The debate between financing versus leasing the purchase of a vehicle is an old one. Almost everyone has an opinion as to which one is best. However, the correct answer should be “it depends”. Mainly, it depends on your needs and what you can afford.
Unless you have the cash on hand, you will likely borrow some or all of the necessary funds from a lender when purchasing a vehicle. The seller (i.e. a dealership) receives full payment to cover the cost of the vehicle, fees, and all taxes. Then, you drive home basking in the ‘new car smell’ in a vehicle that you now own.
All told, you are paying for the full cost of the vehicle (plus interest) over the duration of the loan, regardless of what the vehicle is valued at when you are done (known as the “residual value”). The residual value depends largely on the age, condition, and mileage of the vehicle when the loan is paid off.
How your monthly payment is figured out
The amount of your monthly payment will be determined by a number of variables, three of which are within your control.
The purchase price of the vehicle.
For the same type of vehicle, buying new will significantly increase the cost of the vehicle but comes with the advantage of a new vehicle warranty. Some used vehicles come with limited warranties or it may be possible to buy an after-market or third-party warranty to mitigate the risk of buying a used vehicle. The warranty cost should be considered as part of the purchase price and you might be able to finance it. The most critical factor affecting cost is balancing “needs” versus “wants” in your vehicle purchasing decision. Caution: ‘wants’ are accompanied by an emotional component that can make wise financial decisions a challenge.
The amount of the down-payment
Basically, the larger your down payment, the lower your monthly payments should be. Consider using saved funds for a down payment to reduce the monthly payments and to save on the total amount of interest you will pay on the loan (because you will be borrowing less). If you can delay the purchase and create a savings plan to save for a down payment, that is ideal.
The time over which you are scheduled to pay off the loan (the amortization period)
Yes, a longer-term loan results in lower monthly payments but this can backfire. The duration of the loan should be aligned with the expected life of the vehicle because continuing to pay for a vehicle that is long gone is painful. Be realistic; what is the useful life of the vehicle you want to buy when you consider the amount you expect to drive it? Will the loan be repaid before the vehicle stops working or you need to replace it for some reason? Be conservative so you don’t set yourself up for a problem down the road.
Affordable doesn't mean affording the monthly payment
Lenders are becoming more willing to provide longer amortizations but be careful. You should never finance a vehicle over 7 years – especially if it’s used! There will almost certainly never be a time when the vehicle is worth more than the loan balance and when the loan is paid off your vehicle may be worth almost nothing.
Dealerships are not motivated to help you make the best decision for you – they are motivated to sell you a vehicle and if that means getting you into a long-term low monthly payment scheme, that’s what they will do. Just because you can afford a monthly payment, doesn’t mean that you should.
When planning to finance a vehicle, you need to keep these three variables in mind. You should forecast how long you intend to keep the vehicle and conservatively estimate what the residual value will be when that day comes.
Using your budgeted monthly payment amount, you should be able to roughly work backwards to arrive at what you can afford for a purchase price today. Keep in mind that there will be taxes and fees and they should be part of your total cost calculations since money leaves your bank account to pay for them too. Know the purchase price you can afford and commit to limits before you ever step on a car dealership’s lot!
Lastly, to choose to finance over leasing because you will “own the vehicle when I’m done” is not necessarily a good reason. More on this in Part 2 when we discuss leasing...