Three Ways to Buy a Car: The Good, the Bad, and the Ugly
- Thursday, October 05, 2006
New cars are expensive. In a ten-year period, while inflation grew only about 40% (based on the Consumer Price Index), new car prices rose more than 70%. Today the average new car cost well over $25,000! Anyway you cut it, that’s a lot of money. Since we as Americans have been sold on the idea that it is our birthright to get another vehicle with that "new car smell" every couple of years, paying for our cars has become a major financial issue in many of our homes.
In my travels to over 175 churches and colleges nationwide, I've received a lot of questions about cars and how to buy them the right way.
Although I say this with tongue in cheek, there are three ways to buy a car — and, in my opinion, they are not all equally good. I call them the Good, the Bad, and the Ugly. Let’s take a quick, snapshot overview of these three options in ascending order:
1) The Ugly: Leasing. As car prices went higher and higher, people held onto their cars longer (from 3-4 years up to 7-8 years). Something had to be done to get people back into new car showrooms. The answer: leasing. The promises of lower payments, less hassle, and a new car were compelling to many buyers.
My personal belief, however, is that car leasing is the least attractive way for most people to buy a car. Yes, I’ve heard all the benefits of leasing. At least theoretically, there can be business tax savings, reduced down payments, lower monthly costs, extra insurance coverage, reduced trade-in inconvenience, and other reasons. But since there is so much pro-leasing advertising (roughly 30% of all new cars today are leased), I’m not going to take the space here to make the case for leasing.
I am, however, going to bring some balance to the discourse by sharing some of the things about leasing that concern others and myself. To begin, no matter what you may have been told, a typical car lease is really a long-term rental agreement that may or may not have a purchase option at the end. A car lease is not the same as a car loan! And in a lease, unlike an outright purchase, unless you exercise your option and buy the car, you end up with no ownership or equity. A car loan payment may cost you more per month, but at least you are buying ownership in the car.
Many people believe that dealers prefer leasing because it maximizes their profits. This probably occurs for several reasons including higher fees, lower discounts, and the fact that lease contracts are confusing to many buyers. Add to that the horror stories of high turn-in costs for extra mileage, or what the dealer claims are excessive wear and tear, and you have more reason for pause.
2) The Bad: Car Loans. As you know, I have a bias against borrowed money. Every debt in a person’s life is just that much more bondage he or she is under. It is my goal to be as debt-free as possible — including with my cars. So, do I think it’s wrong to borrow money to buy a car? No. As a matter of fact, there are some occasions when it may be the best option. But remember, that is the exception — not the rule. Most car loans are made because of wants, not true needs.
But, now that I’ve talked myself blue in the face, if you feel that a car loan is the only possible way to go, there are some things to consider. Many people who negotiate great deals when buying their cars lose all their gains when it comes time to arrange the financing. Today, some dealers make more money handling car financing than they do actually selling cars! Dealers frequently bring in consultants and hire specialists to run their "F & I" (finance and insurance) departments. These guys are smart and they tend to know how to maximize the profit potential on the "back end of the deal."
I believe the key to a good car loan lies in this little phrase: Borrow as little as you can, for as short as you can, for as low as you can!
a) Borrow as little as you can. The more you borrow, the harder it’s going to be to pay it back. There are two ways to lessen the amount you borrow: Buy a cheap car and then put down a big down payment. Not easy. Not great for the ego. But, boy, does it make up in peace of mind!
b) For as short as you can. I’m old enough to remember when most car loans were for 36 months or less. Today, some car loans resemble home mortgages. Many people get "upside down" (a phrase meaning that one owes more than the car could sell for) because of loans that last 4, 5, 6 years — and even longer! People, this is crazy!!! I don’t like any loan repayment schedule that lasts longer than about 50% or 60% of the car’s reasonable life expectancy.
And remember, the longer the loan repayment schedule lasts—the more interest you pay. For instance, if you make a $20,000 car loan at 9% for 3 years, the total cost will be $22,896 (including interest of $2,896). But if you finance that same $20,000 car at 9% over a 6 year period, the total cost will be $25,963 (including interest of $5,963). That’s $3,067 more in interest payments!
c) For as low as you can. A third factor that can make or break your car loan is the interest rate. The time to arrange your loan is before you negotiate with the salesman. Dealers are notorious for charging higher rates. Many experts suggest first arranging your loan with a friendly bank or credit union, then start dealing. And, remember, everything is open to negotiation. Don’t hesitate to push for the lowest possible interest rate.
Of course, there are those too-good-to-be true factory loan deals that come along occasionally. If you run across one of these, go cautiously. Make sure you are clear about the rate, and that it applies to the car you’re thinking of buying. Be sure all finance rates are quoted at the annual percentage rate (APR) instead of an add-on rate that may appear to be lower. Never sign a contract until it has all the blanks filled in including the total dollar cost and finance charges. Other details should include the monthly payments and the length (or term) of the repayment schedule.
3) The Good: Paying With Cash. Wow! What a cool feeling! There is nothing else like it. You pick out the car you want and, because you developed a plan and stuck to it, you drive off the lot with a car that belongs to you! Not some lease company, or a bank, or a credit union. It belongs to little, ole you!
Believe it or not, 22% of cars and trucks are sold for cash. Who are these people who can buy a vehicle and pay cash for it? For the most part they’re people just like you and me who have made up their minds to get control of their lives. Instead of living like the masses, these are people who got fed up with business as usual. They decided that eating out all the time and buying designer clothes they couldn’t afford was crazy. They realized that getting ahead was something that only happens when you get really tired of being broke all the time. There was that moment in time when they finally got tired of living on the edge — so they changed things.
The good news is — you can do it, too. Don’t believe the lie that only rich people buy cars with cash. It ain’t true. Lots of people on their way to becoming financially free are buying vehicles and paying cash for them. Besides, how do you think those rich folks got rich? They didn’t do it by making interest payments to someone else.
Next time: Buying Cars with Cash
Steve Diggs presents the No Debt No Sweat! Christian Money Management Seminar at churches and other venues nationwide. Visit Steve on the Web at www.stevediggs.com or call 615-834-3063. The author of several books, today Steve serves as a minister for the Antioch Church of Christ in Nashville. For 25 years he was President of the Franklin Group, Inc. Steve and Bonnie have four children whom they have home schooled. The family lives in Brentwood, Tennessee.
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