A Great Reason to Lease, Not Buy, a Car
The following was a guest post I did that was featured on Money Smart Life.
When it comes to their money, some people do inexplicable things. I came across an appalling figure the other day. The average length of a car loan today is 70 months - nearly six years! Now couple that stat with the fact that, on average, people only keep their cars three to five years. If you do that, it doesn’t take a calculator to figure out you’re digging yourself into a hole.
Upside Down
Being ‘upside down’ is the term used to describe when you owe more on something than it’s actually worth. When you’re talking about cars, it can happen surprising easily.
As a rule, new cars immediately lose value as soon as they’re driven off the lot. It takes several months or even a year of payments to owe less than the resale value of the car. For that period of time, you’re upside down. The longer your loan term, the longer it takes to get to the break-even point.
So it seems that what more and more new car buyers are doing is not entirely paying for a car before they turn around and sell it. Then they buy another car and roll the old loan balance into the new loan. After a few cycles of this, you’re driving a Chevy with a Mercedes-size loan.
The Numbers
To put numbers to the point, let’s say you want to buy this nice new Toyota Camry with a loan of $20,000. If you finance for five years at 6.24% (what my bank offers), you’ll be paying $3,333 in interest over the life of the loan. If your loan term is three years, total interest is $1,770. Financing for the longer term nearly doubles the interest you pay.
If you decide to trade in that car after four years, you still owe over $4,000 on the loan. No problem - just roll that into the loan for your new car.
Do this a couple of times and you’ll quickly be driving a car worth half what you owe on it.
Lease Instead
Since evidently a great many people are doing just that, it seems they should be leasing instead of buying. At least at the end of a lease you don’t owe any money (assuming you fulfill the terms of the lease). Not only that but you’ll be able to afford more car than you would by buying outright.
Like I said, people do unbelievable things when it comes to money.
June 26th, 2007 at 4:09 pm
Yeah but a Camry will be worth $8000 if it is only 4 years old?
June 26th, 2007 at 8:30 pm
Edmunds says a 2003 Camry w/ 50K miles in average condition is worth roughly $9K. $8K for dealer trade-in.
June 27th, 2007 at 9:18 am
Yeah - I can never think leasing is a good idea. It’s obviously a money generator for financing companies or they wouldn’t offer it. By getting a lease, you feel like they take the risk off your shoulders, but you’re still paying more for it. Any time you have a lease with a set term (typically 36 or 48 mo) the finance company determines the residual value, subtracts that from the sales price, throws in their financing on top of the difference, and takes a little extra for the risk they are inheriting. Even if you know the exact term and milage that you want to own the car, buying it is cheaper.
Oh and buying a new car rather than used is a questionable financial decision to begin with. I price my car buying on dollars per mile and a used car will always win. As consumers we’re scared of risk and get convinced to pay extra to not have to worry about the risk. Get a car with 12-15k miles and chances are much slimmer that you’ll ever be upside down.
July 2nd, 2007 at 5:40 pm
I understand why you think that a used car will always win the $/mile race, James, but it’s not entirely the case. If you go back to previous buying new v. used posts on this site, you’ll see that I’ve argued that a car’s remaining useable life cannot be properly determined by the odometer, or even maintenance records! Aircraft engines, for example, have operating hour indications, but they also have indicators for ‘high-power events’. Even at 12-15k, improper USAGE (meaning poor driving practice) has yet to visibly manifest itself, yet it has already had an impact. Modern vehicles are generally designed NOT to fail within the warranty period, but the distance they eventually go without major repair is very much a function of how they’ve been treated. Sometimes being the first owner of something (car, house, boat, etc.) can provide a much more tangible benefit than just piece of mind.
July 3rd, 2007 at 8:28 am
Micah, that’s interesting about military aircraft. I had no idea they record ‘high-power events.’ You point out an often-overlooked aspect of used car buying - previous owner behavior. It’s a big wildcard, but I tend to believe the make/model probably indicates this sort of thing. For example, a Volvo is less likely to have been driven like a race car than a Mustang.
July 3rd, 2007 at 8:48 am
Micah - you are right about driver behavior as being a wildcard, as is the maintenance and care the previous driver took of the car. But when you consider that on average, a vehicle loses 25-33% of its value in the first year, and 50% of its value in the first three years, owning a brand new car 20,000 car at $.4/mile or $6k/yr (assuming 30% in first year @ 15k miles/year) or a decent condition 3 yr old car at $.13/mile or $2/yr (assuming car is worth 10k after 3yrs, and will be depreciated linearly over 5 more) the extra grand or two to maintain the car is pocket change.
** Disclaimer – I know these numbers won’t hit for every scenario, but I tried to keep ratios accurate **
Don’t get me wrong, I’ve purchased the used car that had plenty of “high-power events” and the car broke down faster, but it was still cheaper than $6k/yr to fix and drive. At the end of the day, I advocate driving a car for 6-8 years and think it’s more important to your car purchasing habits than if you choose a new or used car. This way you can buy new, find a car that holds is resale value and still drive it around your $2k/yr figure (20k new and sell for around 5k) and then you don’t have to worry about the previous owner – but you’re certainly not leasing which for a 20k car puts you around 3k/yr. I’ve done both, certainly understand the peace of mind merits with the lease, but think if you can take on the little extra risk and don’t need a new car every 3 years, you’re saving significant money in the long run.
Thanks for the forum to discuss this and keep up the informative topics.
July 4th, 2007 at 12:42 am
My ‘buy new’ theory certainly rests on buying cars that maintain their resale value well, where buying a new car doesn’t cost much more than buying used. And the same things that hold the resale value up (reliability and low maintenance cost) are the same things that a frugal car buyer should be looking for in a car, new or used.
Also, I would argue that most cars today lose only 20-25% of their value within the first year. I think that 25-33% assumption is outdated and based on when cars were only expected to go 80-100k miles. Price new (near invoice) against 1-yr old with 12,000 miles from a private party on vehicles like Honda Accord or Odyssey, BMW 5, Mazda 6, etc. and I think you’ll find that popular vehicles generally only drop less than 20% of their value, sometimes even less. When I was last car shopping, I could choose new for $27k or about 1.5 years and appx. 20k miles (roughly half the warranty) for $21k, only a 23% difference.
Oh yeah, now I remember what the other thing I argued in all the other car buying posts, which you restated nicely: Car buying and selling is a losing transaction (unless you own a refurb shop), so the less car transactions you make of any type (buy, sell, lease, etc.) during your life, the less money you have spent on transportation overall. Not even the get-rich-quick schemers can sell anyone on flipping cars to make a buck!