Buy a Car

Vehicle finance is not as simple as buying a car and getting a loan to pay for it. Vehicle finance is entangled with the warranty coverage, resale value, insurance costs, fuel efficiency and depreciation. It also has a lot to do with price. The cost of cheap financing is often built into the asking price of the car. The cost of cheap financing is often only on cars that are hard to sell. You want to buy a good car not just good financing. You need to be shopping for the best overall deal. That is the one where you get the best car, for the best price with the best financing. You want to minimize your operating cost and maybe build some vehicle equity. You are shopping for the best long term value.

The best way to show how vehicle financing works is to go through an example. The one I will use in this article is very real as one of my children just bought a car. When she came to me for mentoring we looked at 4 examples of what she could buy. I have a 12 year old car with low mileage that she could have bought for next to nothing. She also had her old car that was in a high maintenance period. So she went off to some dealerships to see what was offered. To sort out what was the best deal we used our 3 basic Financial Therapy tools.

The major car companies at this time are offering some extraordinary deals. Price is low and financing is low particularly on new cars. The interest rate for a new car was 2.9% for 6 years or you could get 4 year financing on a 3 year old car at 8%. The new car financing is almost like free money and the price is the lowest that it has been for years on the model we looked at. This is a 2010 car in October of 2009. For a warranty, the 3 year old car that was similar had only 4500 miles (7000 km) of bumper to bumper warranty left on it. The price on the older car was within 15% of the new car. So this was starting to shape up. The last option was the lease. In the lease we put down $250 for the capital cost as they of course wanted a down payment that is not refundable. Then the lease was $280 per month so that is what we entered on the depreciation line plus the interest line. Here is a table that lays it out in black and white for each options impact on a monthly budget. It sure surprised me.

COST PER MONTH

NEW

3 YRS OLD

OLD CAR

LEASE

Capital cost

$280

$333

$100

$250

Depreciation

$120

$150

$100

$230

Interest 

$30

$100

0

$50

Maintenance

$50

$100

$250

$50

Fuel

$120

$200

$300

$120

Insurance

$200

$180

$90

$200

Total cost per month 

$800

$1030

$840

$910

Seeing as how the term of the loan for the 3 year old car is 4 years we chose to examine the impact of each choice on her balance sheet in 4 years from now.




  • By choosing the new car she should have car equity of $8000. She will have paid off $14,880 but the car will depreciate $5800. The rest of the difference is the non refundable taxes that she paid. She will have a $15,000 car asset at that time with just under $7000 left to pay on the balance.

  • The 3 year old car is paid for and is now a 7 year old car. It should be worth $8500 to $9000. Warrantees have expired and mileage will be getting high so the car maintenance should be getting close to those for an old car.

  • The old car will be even old so it will have little resale value. It didn't before so the impact on the balance sheet is 0.

  • By leasing a car you build no equity. If the car holds its value enough that it is worth more than the final payout amount, there may be some positive impact on the balance sheet for buying out the lease. The most important impact of a lease on your balance sheet is that 100% of the amount left on the lease is entered on your balance sheet as a liability. The car cannot be entered as an asset. A lease reduces your net worth.

One thing that you will notice about an older car is that you have reduced capital financing costs but you have increased maintenance costs. This is important because a cost will be incurred to pay for transportation. The question is where do you want to put your focus. If you or your friends are trained and talented in mechanics this question is a no-brainer. Likewise, if you are not the decision is a no-brainer. In the first case you can fix the car and not incur the high maintenance cost or the finance costs. If you are not gifted your time is better spent earning the money to buy a car that minimizes the time and money you spend try to maintain your vehicle. Do things you want to do and that you are good at. You will make more money that way than dealing with a car that constantly needs to be fixed. You will be in control of the situation and you will not get stuck in a vehicle and miss money making opportunities.

Conclusion

Buying the new car just made sense. You can't argue with the numbers. The impact on her budget is smallest plus she builds as much car equity in 4 years as buying the 3 year old car. The only dark spot is that she will be making payments for 2 years longer but she will maintain her low interest rate. Maintaining an old car would be a distraction from the other facets of her life and from her budding career. I think this instance was an anomaly. Usually the 3 year year old car is the best deal. That is why you always use your budget and balance sheet to analyze opportunities. Sometimes there are windows of opportunity for you to find a deal that you never expected. You may suspect that it is a good deal but your budget and balance sheet prove it to you one way or the other.