Car Purchasing: the Advanced Lesson

Like most people in North America I have carried a debt load since I was a young adult in University (coinciding with obtaining my first crdit card). As I discussed here DH and I have cycled rather rapidly between heavy debt loads and enjoying debt-free status over the five years we’ve been married, and our experiences have left us very shy of financing. We pay cash for everything – computers, furniture, etc.

And we vowed that we would never finance a car.

Locking into large monthly payments for 4+ years is a frightening proposition for a couple who have seen such violent swings in fortune. So when the idea of getting a new car hit me a few months ago, we figured we could make this work if DH’s bonus was what we were expecting and/or hoping. When the numbers were finally revealed to us last week we were faced with a dilemma – the signing (cash up front) bonus was too small to pull us out of debt *and* pay for a car in full, but the annual salary/annual bonus created a host of opportunties. This meant looking at car purchasing in a whole new light, which is what I’m going to discuss now.

You can Google “lease vs buy” and come up with a host of articles discussing the two main options for car buying. I’ve bought two new cars in my life and I financed both of them because I planned on keeping them for the long term, and living “car payment free” for a time after paying them off makes for very inexpensive transportation. Leasing didn’t make sense to me then, except in the way that some people use it which is to get more car than you can afford. This, to me, is a wrong move not just from a financial perspective, but a “moral” one. It’s part of the “buy now, pay later” culture that my generation has grown up in, and which I blieve is responsible for the debt loads pretty much every citizen of Canada and the US carries.

But, I have discovered that there are times when leasing makes sense. And we seem to be candidates for this. We have found the vehicle we want (and it wasn’t a Honda CRV after all; I’ll show you a photo when the deal is done) and the monthly payments for financing it are definitely doable without strain. As is usually the case, the monthly lease payments are about 2/3 of the financing ones, but because neither option is unreasonable from a budgetary perspective, choosing to lease would not be a case of “buying more car than you can afford”, so we’ve jumped over that hurdle right off the bat.

What I’ve learned is that the choice of lease vs. buy depends on what sort of time frame the buyer is working on. If you want a car that will take you the next 6 or 7 years (as my last two have) or even 10 years or more (as many cars can do) then financing is the way to go. But for us the issue is more short-term. Our biggest “fear” is that we are going to up and move to the US or somewhere else to persue an opportunity for DH. It’s not an immediate concern, but it is a real one and given how often we’ve done this you can see why it looms large in our minds. So we’ve asked ourselves which option makes sense if you go into, say, a 4 year lease or loan and then, two years into it, you have to get rid of the vehicle.

If you are financing this is a big Lose situation. Not only will you suffer the rapid depreciation that occurs in the first year of owning new car (I’m not going to discuss the “new vs used” issue; suffice to say we’ve made that choice already), but you will lose all the taxes you paid. Here in BC that amounts to 13% which, on a $35,000 car is $4550 and gets worse as the price of the car goes up. When you consider that, and the substantial PITA factor involved in selling a vehicle when you are organizing an international move (or going to a Cash For Cars place and taking a much bigger $$ hit), this is a very poor situation that will cost you mucho dinero.

On the other hand, if you are leasing and have to leave early, assuming there are no fines or penalties involved (and for our car of choice there are none), then what you pay is the difference between what you would have paid on the rest of the lease, and what the car’s current appraised value is. While you will likely end up owing money, it should be less than what you’d take as a loss in the financing scenario, especially if you choose a vehicle with low depreciation and you treat it well. And the biggest advantage is that, when you lease, you pay no taxes up front, but just tax on each montly payment. This is a substantial difference, particularly with more expensive vehicles.

For this reason alone DH and I should lease. But there are other benefits worth mentioning. At the end of the lease period you have the option of purchasing the car by paying off the “residual”. Now if you go ahead and finance this then you really are going to end up paying alot more for the car than you would if you financed it from the start. But, if you are in a position by then to pay it in cash, you might actually get a good deal, particularly if the vehicle didn’t depreciate as much as the residual estimated it would (in which case you get it for less than it’s worth).

The final point I want to say is this: I always thought that borrowing money to obtain a car, whether you lease or buy, is always worse than paying cash up front. And we struggled with this point – we hate carrying a debt load. But I learned that this isn’t always the case. I’ll let you decide whether the following points are valid, or if we are simply justifying our consumer urges to “buy now and pay later”…

Virtually all financial planning books and experts say “pay yourself first”. So if you are going into debt (and I see leasing as a debt), are you taking away from money that would be better placed elsewhere? If, for example, you are carrying debt on credit cards then it would be wiser to pay that off first and then think about getting a new car. The flip side of this is: are you saving enough to justify the financing? Here’s an example: let’s say you contribute the maximum each month to your RRSP (401k for you US readers); this is a pre-tax earning that reduces the amount of income tax and increases net annual pay in real dollars. If financing/leasing a car allows you to do this, then compared to saving up the money in a non-tax sheltered vehicle (or using a lump sum of cash) to buy the car outright, I think you are better off borrowing. The benefits of having more cash and money each month to fulfill your maximum allowable RRSP contribution is better than the loss of interest you take on borrowing the money for the car, and that isn’t just if your RRSP investments earn higher interest, it’s because of the tax savings and increase in real income. So what we concluded is this: if we are not in debt and if we maximize our monthly RRSP contributions, and if it doesn’t represent a strain on the monthly budget, then spreading the cost of the car over time is acceptable.

I’ll let you know how this all pans out. In the meantime I hope my research has been of interest to at least some of you. Okay, one of you. 🙂

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Categories: Uncategorized | 2 Comments

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2 thoughts on “Car Purchasing: the Advanced Lesson

  1. Nicki

    Count me as that one! ;)I’ve only owned 2 cars in my life, both bought used and both paid cash, so I know nothing of buying/leasing a new car from a dealer. The point that’s always been most confusing to me is, if you lease a car, what happens if the worst happens and it gets totalled in an accident? (Assuming the people are fine) Do you end up still having to pay monthly lease payments while not having a car any more? I’m just rambling I suppose, cause I guess you’d still have to pay the bank off if it were financed..?

  2. Midlife Traveller

    Most leases include GAP insurance, which covers that exact scenario…

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