Your First Car: Buying vs. Leasing vs. Financing

I realize that this may seem a little unrelated to the rest of this site, but I recently went through this process so I figured I would share my findings. Buying your first car is one of the biggest purchases you will make in your life, so it is important to weigh all of your options before doing so. The difference between paying for your vehicle in cash, financing or leasing can be thousands of dollars over the lifetime of the car.Mitsubishi Lancer As an example, let's examine a new vehicle with a list price of under $15,000. You can get more bang for your buck by purchasing used, but it's easier to compare using new models.   Now let's analyze the 3 payment options.

Financing

Financing involves borrowing money to purchase the vehicle over a number of years from a credit union, the automaker, or a bank. When financing, the interest and fees that you pay can really add up. Interest is generally the third most expensive cost of owning a financed car (besides insurance and your monthly principal payments) (ConsumerReports, 2012). To prove this, we can have a look at the typical costs to finance a brand new vehicle.

  • As a young adult, you would likely qualify for a 5 year loan with an interest rate of about 6% (given that you have built a reasonable amount of credit).
  • There is usually a down payment of 15% when financing, which would be $2250 on a $15,000 new car.
  • At the end of the 5 years the cost to finance the vehicle would be $17, 039 with 6% interest. But what if the automaker offers a 0% Annual Percentage Rate (APR)?
  • This rate is only applicable to those with good to excellent credit (higher than a score of 600)
  • Most young adults will not have a high enough credit score to qualify for 0% APR, and will be lucky to qualify for a rate of 6%
  • If you DO qualify for 0% APR, you will likely have to pay the list price of the vehicle
    • If paying cash for the same car, you would have a better chance of negotiating a better deal

It is also more difficult to sell your car when it is financed.

  • As long as there is money owed on the car the lender holds the title. If you wish to sell the car while you are still making payments, you must buy the title from the lender. In some cases, people have had to take out another loan in order to buy the title.
  • Owing more money than the vehicle is worth is known as being 'upside down' on your loan. This often happens when the payment period on the vehicle is long-term (since cars depreciate very quickly).

Leasing

Leasing is the least common way to acquire a new vehicle. It is essentially renting your car for a number of years (usually 3 to 5 year terms). Once you turn in your lease, you have nothing to show for it. Unlike paying cash or financing, you can't sell the vehicle in the future to recoup a portion of your investment. You do have the option of buying out or taking over the lease at the end of the term, but this is usually very expensive. When leasing, you are also not free to do as you wish with your vehicle.

  • Leasing agreements limit the amount that you can drive without being penalized.
    • There is usually a restriction which limits your driving to between 15,000 and 25,000 km a year.
    • Thereafter, compact cars are charged about 12 cents per each kilometer driven over the limit (Gordon Wright, 2011)
    • I drove 30,000 km last year. This means that if I had the most expensive lease which allowed for 25,000 kilometers, I would still be charged about $600 each year on top of my lease payments ($3000 over the five year lease).
  • Inspections upon returning the car can cost you extra if the vehicle is damaged or modified.
    • There are tons of stories of consumers being charged thousands of dollars for minor issues with the vehicle, or aesthetic changes that were made
    • The auto maker will charge the customer whatever it costs them to return the vehicle to it's original factory specifications
     

Paying Cash

Now I know what you are probably thinking. I don't have $15,000 saved up, so that's not an option for me. Well by planning ahead and saving, you can save thousands in the long run. Working full-time, it is quite possible to save $500 each month for the next 2.5 years, or $250 each month for the next 5 years. Not including interest accumulated, this would equal $15,000. Let's look at a few of the other benefits of paying cash:

  • Fewer monthly expenses will free up your budget.
    • The money that you save from paying interest can be invested each month. In our previous example you would be paying $34.38 in interest alone each month. Here in Canada, this could be invested in a tax free savings account which could earn close to an extra $500 each year.
  • There is more of a safety net in case your future isn't secure.
    • There are other expenses involved with owning a car such as gas, insurance and regular maintenance. By eliminating monthly financing or lease payments, these expenses are more bearable.
  • Paying with cash is less of an aggravation.
    • You don't have to qualify for a new vehicle (can take hours or days). Your credit information will also need to be accessed when leasing or financing.
  • There are no hidden fees when paying cash.
    • No chance of a 'bait and switch', where the lender may change their mind about the agreed upon interest rate. This is known to happen, in which case you will be forced to either accept the higher interest rate, or return the vehicle and start all over.
  • The peace of mind that comes with owning a paid off car is worth saving up. You'll also enjoy driving the car that much more knowing that is is all yours!

Summary

You are now aware of the reasons why you should pay cash when purchasing your vehicle in a few years. By avoiding financing or leasing you are paying less over the life of the vehicle, you can do as you please with your car, and have more financial security going into the future. If you remember these things when it comes time to buy your first car in a few years and decide to pay cash, you will secure the best deal possible. Take it from Randy Moss:

Cost Recap

Financing: $17,039 Leasing: $13,020 (plus $3,000 in extra kilometres) Paying cash: $15,000
Over 5 years, not including taxes

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