By Markus Allen
Founder of TruthIn7Minutes.com
All throughout my adult life, I've either leased or financed cars.
In fact right now, I drive a leased car and my wife drives a financed car.
Both methods of financing offer advantages and disadvantages.
For us, the biggest factor on deciding which is best always came down to cash flow.
Should we buy a car with cash?
Of course, buying a car with cash is the Great American Dream. We don't have to worry about monthly payments. We can pimp our ride. The car's title is in our name (instead of a bank) so it's way easier to sell. And if we hit a financial "rough patch," at least we still have a car to drive without having to deal with the repo man.
Buying a car with cash saves us money almost the instant we drive a car off of the lot. Obviously, there's no interest to pay. And insurance is cheaper, too (as we don't need to get collision, comprehensive or gap insurance).
Paying with cash has its downsides, too. Doing so takes away a huge chunk of our bank account balance... leaving us high and dry with limited funds for a rainy day.
Since cars depreciate, paying for one isn't a smart investment.
And if we're using the car purchase in a business, we might lose out on the maximum tax deductions.
Should we lease a car?
When leasing, we don't own the car. We're renting it for a predetermined number of months.
When we add up all of the costs of leasing (the payment, insurance, taxes, mileage and repairs), it's almost always cheaper than financing.
Unlike financing a car (when we pay the principle, interest and all taxes), lease rates are largely based on the car's estimated residual value when we turn the car in. That's why the leasing payment is almost half the price (compared to typical car financing).
In most states, we pay taxes based on the total lease payment, not the overall price of the car.
For us, the big determining factor is mileage allowance. For my current car, I'm allowed to drive 1,000 miles a month (or a total of 36,000 miles for a three-year lease) without extra mileage charges. If I go over this amount, there's a surcharge of 15 cents per mile - this varies lease to lease... dealer to dealer... or bank to bank...
... I don't drive my car much these days. We do most of our trips in my wife's car. That's why I lease my car, and my wife financed her car.
If you're like us and hate surprises and the stress of driving a car that might need repairs, leasing might be for you. Since most leases last three years, the car is almost always covered by the car manufacturer's warrantee.
If you get bored easily, leasing is the way to go. Just turn in your car at the end of the term and drive home in a new car the same day (if you do the deal with the same car company).
Initial out-of-pocket costs with leasing are substantially less than traditional car financing - in fact, if we have a great credit score, we can lease with no (or very little) money down.
Leasing might be the only option when driving expensive cars - most banks won't lend more than $30,000 for a car loan.
Of course, leasing has nasty downsides... especially when we turn in our car after a lease and walk away from the dealer without a new set of keys - many report getting invoiced for ticky tacky damages.
Some hate throwing money down the drain, because with leasing we never own the car.
Insurance rates might be higher, too... we're forced to get additional coverages (although this is also true for financed cars).
Finally, it's against a lease agreement to make any modifications on the car - so if you're into pimpin' your ride, leasing is not for you.
Should we finance the purchase of a car?
If you're looking to own a car outright, but can't pay cash for it, financing is the most popular option. About three out of every four cars bought are traditionally financed.
With financing, you pay a monthly rate for a pre-negotiated period of time. Loans are available through the dealership, credit union or traditional banks.
Financing is a cash-flow killer, though - creditors ask for up to 15% of the total loan upfront as a deposit.
Residual value is an important factor to account for when financing a car. Not only do we want a car that's proven to hold its value...
... But we also want to safeguard ourselves from an accident - especially within the first few years after the purchase... the amount left on the loan may be greater than the worth of the car. When this happens, our loan is "under water" (just like most mortgages these days) and we're on the hook for the difference. That's because your regular auto insurance is designed to pay the lender the vehicle's current cash value, not the current loan balance. And once your new car (owned or leased) leaves the lot, it's considered a used car and the value of it drops significantly.
Insurance companies offer "gap insurance" to cover this for us. To lower the cost of gap insurance, buy a car that tends to hold its value over the years. For example, buy a compact truck... like a Toyota Tacoma. After five years, it's projected to be worth 57.3% of its new car price. On the other end of the value scale, the Chevrolet Cobalt retains less than 20% of its initial value after just five years of ownership.
Most cars lose about 20% of their value the moment they're driven off the dealer lot.
Of course the biggest benefit of traditional car financing is we get to drive as many miles as we desire. If we're into making modifications, we're free to do so. And if we tend to be "unlucky" or drive the car hard (and get dings), it's all good - because our car is ours to keep when the payments end.
Like anything, there are downsides to financing a car:
Unfortunately, the tax deduction on interest is no longer available (like it used to be).
Warrantees almost always expire before the term of the financing ends... and we're responsible for paying for these repairs. And of course as the car ages, the problems seem to increase.
For me, the biggest downside of traditional car financing is it's a HORRIBLE investment - the car is worth less money the instant we drive it off the dealer's lot. And once we pay the car off, the value of the car is less than half of what it was new.
The bottom line is figuring out the best way to buy a car is totally dependent on each person's situation.
Of course educating yourself about the best ways to intelligently get the most car for the least amount of money always pays off.
P.S. Have a look at my other investigations, videos and podcasts and get the real truth about life...