Who can resist the tantalizing advertisements that portray a happy family, successful businessman or beautiful couple driving into the sunset in a shiny new car—all for “just dollars” a month? A new vehicle decision is often an intimidating process with a lot of unknowns. Since a vehicle purchase is rarely considered a “good investment” let me give you three important questions to consider when making this decision.
1. Why this particular vehicle? Are you trying to minimize your annual costs? Provide comfort or safety? Achieve a dream of owning a particular vehicle? Your motivation will typically drive the decision down a path that suits your desired outcome. For example, if owning the car of your dreams is your motivation, it can be tempting to ignore financial prudence because you would do just about anything to drive that car off the lot. For the record, I’m not suggesting owning a car of your dreams is right or wrong, rather that you consider your motivation and then evaluate if this is a wise decision. From a strictly financial perspective, my research points to the considerable financial advantages of buying a newer used car and driving it for eight to 10 years. This avoids some of the immediate depreciation that occurs when you drive a new car off the lot. I’ve also seen a new car purchase make sense, however, if negotiated carefully and you drive it for a long period of time.
2 When should a vehicle be replaced? There are three basic economic reasons for replacing a car. Time, when it requires too much of your time to keep it repaired. Repairs, when it costs more to fix the vehicle than it is worth. Safety, when you or your family’s well-being is at risk.
3. How should I pay for it? I generally advise paying cash, when possible, both for the psychological and economic benefits. Cash typically causes people to make better decisions because it’s a reality check—you’re about to trade an important part of your life (hard-earned money) for something you’ve found worth trading it for. It forces you to answer this opportunity cost question: Is the vehicle really worth it? This is especially true for those prone to replace cars often. It’s much easier to borrow tens of thousands of dollars because you can make “easy monthly payments.” If you aren’t at least willing to pay cash, I’d pause and evaluate the value of the decision.
Do you need to finance? I have seen some offers in this low-interest rate environment that may make me bend my pay cash guideline a bit. For example, when the interest rate charged by the lender is about half of what can be earned through short-term financial investments, borrowing some of the funds may be an acceptable alternative. My caution here is to negotiate carefully and work toward being able to eventually purchase your next vehicle with cash because interest rates may not be this favorable in the future. It can take many years to get to the point of being able to pay cash for a vehicle outright, but with discipline and perseverance it can be done. Make a commitment now to pay your vehicle off as quickly as possible and then continue to save that monthly payment for your next replacement.
So what about leasing? Let me give you the bottom line—leasing will rarely be more advantageous than paying cash or financing under favorable terms. A lease is set up primarily for convenience to the consumer. Yes, it does save you some hassles and you avoid having to re-sell your vehicle, but you will pay for it. If that is acceptable and you are looking at leasing purely for the convenience, go into it knowing that convenience does have a cost.
When it is time to replace your car, it is often tempting to think in terms of a monthly payment rather than the long-term impact of the financial decision you are about to make. Acquiring a highly depreciating asset like a car is a decision that should be made cautiously, not impulsively. Use wisdom and care as you consider this important, but expensive, necessity in your life.
With all this caution, am I driving you crazy yet?
— by Janice Thompson
Thompson is a certified financial planner, and co-founder and CEO of One Degree Advisors, Inc. She speaks on financial topics and is a mentor for financial professionals, she also serves on the board of directors for Kingdom Advisors. Learn more at onedegreeadvisors.com. Advisory services offered through One Degree Advisors, Inc. Securities offered through Securities America, Inc., Member FINRA/SIPC. One Degree Advisors and Securities America are separate companies.