Time For A New Car?

When it's time for a new car, you're faced with a host of decisions: not just which car to get, but how? Will you buy or lease? If buying, will you look for a new car or a used one? Be aware of your options, and understand the financial implications of each.


Buying a New Car

Purchasing a new car gives you full ownership of the vehicle. It's yours to do with as you please: you can drive it a little or a lot, take good care of it or neglect it, choose to fix cosmetic damage or live with it, add custom details and enhancements. New cars come with warranties, which means that you don't pay for any necessary repairs, beyond routine maintenance and damage due to accidents or misuse. You can keep it for as long as you like, and when you're ready to replace it, you're free to sell it, trade it, or give it away.

Most people finance a new car purchase with a loan, so their purchase is accompanied by monthly payments. The size of your monthly payment depends on the price of the car, your down payment, and the interest rate on your loan. On the day you purchase the car, you pay the down payment, sales tax on the entire price of the car, and registration and title fees required by the state.

Everything but state fees and sales tax are negotiable, beginning with the price of the car. Unless you're buying a highly sought model that's in limited supply, don't pay the MSRP -- the manufacturer's suggested retail price, displayed on the sticker. The dealer expects you to make an offer of a lower price. Do your homework, and then learn how to negotiate your best deal.

Owning a brand new car may provide you with a great deal of value in terms of personal enjoyment. That's something pure financial advice can't address; it's a factor you must estimate and consider yourself.


Leasing a New Car

Leasing a car sounds a lot like renting, and, in many respects, it is: You pay a pre-determined amount of money each month, for a specified period of time. At the end of that time period, you return the car and walk away, without ownership and without obligations. On the day you lease the car, you pay only your down payment; sales tax is included in your monthly payments, which begin at the end of the first month.

This scenario is true in the simplest case, but there are circumstances that can complicate the picture.

Almost always, a lease requires you to:

  • keep the vehicle in good condition. You are responsible for routine maintenance, such as regular oil changes. You are also expected to prevent anything beyond "normal wear-and-tear": no large dents or scratches, no significant tears or stains in the upholstery, no broken radios.
  • drive no more than 12,000 miles per year. If you expect to put more miles on the car, you can negotiate a higher mileage limit, but that will add to your costs.
  • make no modifications to the vehicle.
  • keep the vehicle for the entire length of the lease. In terms of this obligation, a lease is more like a loan than a rental agreement: you are responsible for the full term of the lease, even if your preferences or unavoidable circumstances bring about a change of heart.

Violating any of these conditions will result in extra charges at the end of the lease.

An important add-on to a lease agreement is an insurance referred to as gap coverage. If you lose the vehicle to theft or accident before the end of the lease term, you're still obligated to make the remaining monthly payments. Gap coverage takes care of those payments for you.

Leasing is financially more complex than buying. If you're considering leasing, you should understand the basic financial details involved.

Leasing may enable you to drive a more expensive car than you could buy -- but don't assume that's the case simply because your monthly lease payments would be lower than monthly loan payments on a purchase. See Which Choice Is For You? for more information.


Buying a Used (or "New-Used") Car

A used car was once the epitome of a dangerously unpredictable purchase -- but no longer. Used cars are commonly sold by reputable car dealers. "Lemon laws" protect consumers who have inadvertently purchased cars that are in much poorer condition than advertised. So-called "new-used" cars are readily available: two- to three-year-old vehicles just returned from lease, or cars that were used for a year or two as well-maintained rentals. Often, these new-used cars have time left on their manufacturers' warranties. And information about used car values and accident histories enable you to be just as well informed about a used car as you would be about a new one.

New cars lose a significant amount of their value -- sometimes as much as 10% -- as soon as they leave the dealer's lot. It's not hard, therefore, to save a great deal of money by purchasing a car that's very close to brand new.

Do your homework, then learn to negotiate your best deal on a used car.


Which Choice Is For You?

Generally speaking, if you would keep a new car for only a short period of time -- two to three years -- leasing is financially advantageous to buying. If you would purchase and keep a new car for six years or longer, buying is a better deal than continuing to lease new cars every two to three years. In the mid-range, the two choices are financially about the same.

If you are willing to purchase a previously owned vehicle, you can always spend less than if you bought or leased the same car when it was new. You take some risks with repair costs, however, assuming you keep the car past the end of its warranty.

There is no single "best" choice for acquiring a car. The following general guidelines, however, may help you decide.

Buying a new car is probably best for you if:

  • you're sure you want a new, rather than used, car.
  • you plan to keep your vehicle for more than 5 years.
  • you drive more than 12,000 miles per year.
  • you want the option to sell the vehicle at any time.
  • you want the option to customize the vehicle.
  • it's important to you to own your car.

Leasing a new car is probably best for you if:

  • you're sure you want a new, rather than used, car.
  • you plan to invest the difference between lease payments and new car payments (or use it to pay off debts).
  • you want to have a new vehicle every two to three years.
  • you are fairly certain that you will drive no more than 12,000 miles per year.
  • you are fairly certain that you won't face changing financial circumstances over the next two to three years.
  • you are fairly certain that you won't want to move out of state over the next two to three years.
  • you take good care of your vehicles, both mechanically and cosmetically.

Buying a used or new-used car is probably best for you if:

  • the appeal of a new car isn't particularly important to you.
  • you're willing to risk incurring some costs for repairs.

Doing Your Homework

If you are looking to buy or lease a new car, find out the following facts before you enter a dealer's showroom:

  • the make and model you want to buy or lease, as well as any features that are very important to you
  • the invoice price of that vehicle.
  • the "blue book" value of your trade-in.
  • the prevailing interest rate for new car loans: contact Northwestern Bank. If you plan to lease, convert that number to a money factor -- the number typically used by leasing companies to represent their finance fees -- by dividing it by 2400.
  • the residual value of the vehicle, if you plan to lease.
  • your credit score: the better your credit, the lower the interest rate you can negotiate.

If you are looking to buy a previously owned car, find out the following facts first:

  • the make and model you want to buy, as well as any features that are very important to you
  • the "blue book" value of that vehicle.
  • the "blue book" value of your trade-in.
  • the prevailing interest rate for used car loans: contact Northwestern Bank.

Once you have identified one or more used vehicles that interest you, but before you begin any negotiations with the dealer:

  • record the vehicles' VIN numbers. A VIN is a 17-character Vehicle Identification Number, typically etched into the top of the dashboard and visible from the windshield.
  • find out the accident histories of the vehicles.
  • insist that the dealer deliver the vehicle to your mechanic -- preferably, one who has no ties to the dealer. Use your mechanic's estimate of any necessary repairs to negotiate with the dealer. Your best choice is a car that your mechanic tells you needs no repair.

Negotiating Your Best Deal

Purchasing or leasing, the process of obtaining a car is complicated by the necessity of negotiating. The price tag is not the price you should pay! Not only the price is negotiable. The value of a car you may be trading in and the interest rate on your loan are both negotiable.

  • Come armed with the facts. There is no information that the dealer can give you that you can't find out on your own beforehand! You'll enter into a negotiation that will hold no surprises. You'll know what your bottom line is. See Doing Your Homework for guidance.
  • Negotiate the purchase price, not your monthly payment. That's right: in both buying and leasing, the important figure is not the monthly payment, it's the full price of the car. In leasing terminology, that's the capitalized cost (cap cost), or lease price. Negotiating your monthly payment with a dealer gives the dealer too much room to charge you too much money for the car. And remember: in both buying and leasing, price is always negotiable. Don't pay the sticker price!

It's likely that you've begun your own calculations by determining how much you can afford to spend each month. No matter: if you plan to lease, find the estimated residual value of the vehicle (its value at the time you will return it), then use this online calculator to determine the corresponding cap cost. If you plan to buy, use this online calculator. In either case, negotiate the target price you calculate here, not the monthly payment.

  • Negotiate up from the invoice price, not down from the sticker price. The sticker price is irrelevant. Begin with the invoice price, and be prepared to pay a reasonable amount more than that. Generally speaking:

-- If the MSRP is $25,000 or lower, then $300-$500 over invoice is fair.

-- If the MSRP is between $25,000 and $40,000, $500 to $1000 over invoice is fair.

-- If the MSRP is over $40,000, then $2,000 to $3,000 over invoice is fair.

  • If you are leasing, be sure to sign a closed-end rather than an open-end lease. At the end of the lease term, the car may be worth less than the residual value estimated when you signed the lease. With an open-end lease, you would owe the difference; with a closed-end lease, you don't.
  • Don't be taken in by a dealer's tricks. Common ploys to avoid include:

--Asking for your driver's license or credit card for any reason -- even just to make a copy of it. Don't hand it over! With either of those in his possession, the dealer has you held captive. You need to be free to walk away from the deal! Make copies of your driver's license before you go to the showroom, and be willing to give a copy to the dealer. Write YOU MAY NOT RUN A CREDIT CHECK on the copy, and remind the dealer that running an unauthorized credit check is illegal. (Credit checks run by dealers can lower your credit score.)

--Telling you that your research is inaccurate. Don't fall for it!

--Requesting a deposit during negotiations. Don't pay any money until the deal is signed!

--"Losing" the keys to your trade-in.

--Charging for "add-ons" such as credit insurance, rust-proofing, prep fees, and administration fees. Reject these unnecessary products and services. (An exception to note is gap coverage, which is a good idea.)

If a dealer is too persistent about these ploys, simply leave. You can find a more ethical dealer elsewhere.

  • Be willing to walk away. Unless you're shopping for a rare vehicle in high demand, you can find what you want elsewhere -- and the dealer knows it. He may or may not make concessions once you stand up and put on your coat, but you've lost nothing if he doesn't. (And if you can't get the deal you need anywhere, it's because you can't afford the car, and you need to downgrade your expectations.) It's not rude to say "no thank you" and leave!

Calculating the Financial Differences Between Leasing and Buying: an Example

The lure of leasing is lower monthly payments. Almost always, the monthly cost of leasing a car is less than the monthly loan payment for purchasing the same car. It's wise, however, to look at your overall costs: at the end of the lease term, the leasing customer doesn't own the vehicle. The purchaser does, and can recoup some of his expenses by selling the car.

Online calculators can quickly show you the cost differences between buying and leasing a specific vehicle and keeping both for the same amount of time. (Note that, regardless of the length of the loan you specify, the calculator assumes that you would sell the car at the same time you would have returned a leased vehicle.)

Consider the following example, which shows an online calculator's figures for buying or leasing a $20,000 car and keeping it for three years.

Purchase price: $20,000

Sales tax rate: 6.00%

Interest rate: 8.00%

Down payment: $1,000

Loan payment: $410 per month

Total cost to purchase = downpayment + loan payments + outstanding loan balance - market value of vehicle = $14,561.10

Lease payment: $317 per month

Total cost to lease = downpayment + lease payments = $12,423.37

The monthly lease payment is lower than the monthly loan payment, as expected. And, even though the purchaser earns some money by selling the used car, his net expenses are still higher than if he'd leased the same car. If you would keep a new car for only three years, you're likely to find that leasing is a better choice than buying.

What these online calculators don't show you is what happens if you were to purchase and keep a new car for longer than a typical lease term. Leases are generally available for no more than three years. To continue leasing, you would return your vehicle and enter into a new lease agreement, starting payments all over again. To continue owning, of course, you would continue making payments only until you have paid off your loan.

Returning to the scenario above, if we now assume that the purchaser would keep the car for three more years, then the figures change:

Total cost to purchase

= downpayment + loan payments - market value of six-year-old vehicle

= $21,257.47

Total cost to lease

= two downpayments + six years of lease payments

= $24,846.74

The purchaser has paid off the entire loan and then sold a six-year-old car. The leasing customer has leased a second car for another three years, doubling his expenditure. If you would keep a new car for six years or more, buying is generally a better option than leasing.


Interested in speaking with a loan officer about your options? Contact your local office or e-mail consumer loans: loan@nwbank.com.

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