Shift Gears, Steer Decisions: Your Roadmap to a Smarter Car Purchase (1Q24 Wealthwise by WEIL)

March 15, 2024

Jon Strauss, CFP®

Vianca Tabuena, CFP®

Rob Gaan CFP®

My First Forays into Car Buying – Jon Strauss, CFP®

My frugality, long before advising on finances, took me on some uncomfortable paths. Case in point, my car buying approach. Post-college, recognizing the impracticality of my gas-guzzling truck, I embraced economy. This led me to a Ford dealership where I chose the most budget-friendly and reliable option; the noble Ford Fiesta.

Despite the high probability of having overpaid, along with signing up for unnecessary warranties and other rookie oversights, my affection for that car remained. Fast forward to 2021 and my beloved car was a mere echo of its past, with a stuck driver’s window, a temperamental transmission, and a radio that demanded manual fuse interventions every time I wanted to turn it off. My wife Mary rightfully lobbied for a new car as the Fiesta’s limitations grew untenable. Eventually, I conceded; it was time to retire the Fiesta, our resilient family staple, and face a new automotive chapter.

The question loomed. Why did I hold out for so long? Was it my ingrained sense of frugality or was it a deep-seated aversion to the labyrinthine process of selecting a new vehicle? On reflection, it was clearly the latter.

The car buying journey is fraught with a plethora of choices: financial planning, feature comparisons, and forecasting family necessities. Knowing all this, let’s dive deeper into the critical elements that should be considered in your next car purchase.

Navigating Car Buying with the 20/4/10 Rule - Vianca Tabuena, CFP®

In the final quarter of 2023, car financing had reached eye-opening figures. Nerdwallet.com reports that the average new car loan is $40,366 with a monthly payment of $738 at 7.18% interest over nearly 68 months. Used car buyers are seeing average loans of $26,685 with monthly payments of $532 at a higher 11.93% interest over a similar period.

Much like planning for a house, car buying should be a mix of desire and practicality, aligning your ideal vehicle with your financial circumstances. The 20/4/10 rule serves as a guide to ensuring a prudent purchase:

• Put down 20%: Aim for this unless you secure a deal with 0% or sub 5% interest (which used to be more common, but is now pretty rare). This mitigates for excessive interest and the risk of owing more than the car’s value.

• Avoid loan terms of four years or more: Dealerships may entice you with low monthly payments over extended periods, but it leads to higher interest paid over time, benefiting the lender.

• Spend less than 10% of your monthly income on transportation: Loan payments, insurance, fuel, and maintenance should not exceed 10% of your take-home pay. For maintenance, regularly set aside a small amount to cover routine services or unexpected repairs.

New vs Used - Jon Strauss, CFP®

Buying a new car often offers the latest in safety, efficiency, and technology with the added benefits of warranties and often lower financing rates due to promotions. However, a new car’s value drops by about 10% immediately after purchase, with further depreciation to follow. It shouldn’t be assumed that buying a new car is a guarantee of reliability, as some new cars, like my Fiesta, come with their own set of problems. On the flip side, used cars depreciate less rapidly after their initial loss in value and may offer better long-term performance, particularly if you choose a model with a reliable track record. Although you’ll likely pay less for insurance and annual registration, you risk unknown past issues and potential repair costs that may not be covered by warranty.

When making your decision between a new and used car, consider the following:

• You may prefer a new car if:

• you prioritize cutting-edge features and warranty security,

• you’re concerned about battery life and potential replacement costs, especially for EVs/hybrids,

• you’re looking for lower financing rates and promotional deals, and

• you want a worry-free purchase with a manufacturer’s warranty.

You may prefer a used car if:

• you value retention and overall cost more,

• you prefer cheaper insurance premiums,

• you prefer to minimize your carbon footprint, and

• you’re looking to avoid high depreciation.

In either case, if you want to ensure a good resale value, choose a model known for its durability, whether new or used.

Buy vs Lease - Rob Gaan, CFP®

Buying a car means ownership, with the freedom to drive unlimited miles and customize your vehicle. Most buyers finance their purchase with a 2 - 5 year loan, incurring monthly payments and eventually selling the vehicle for a residual value that can be applied toward the purchase of a new vehicle.

With a lease, you are paying to drive a new car without owning it. You have use of the car on a temporary basis, typically over 2 - 3 years. Once the period ends you simply return the car to the dealer or purchase it for a pre-determined price. Lease payments are basically the difference in value from when the car is new and the residual value of the car when the lease period ends, plus some finance charges.

Benefits of leasing include:

• driving a new car during its most reliable years with warranty coverage and potentially included maintenance,

• affordability of a better vehicle due to lower payments,

• access to the latest safety features and technology,

• possible tax deductions for businesses, and

• no resale worries, simply return the car at the lease end.

Drawbacks include:

• endless payments if continuously leasing,

• mileage limits with penalties for excess,

• charges for abnormal wear-and-tear,

• potential early termination fees,

• additional costs, like tire replacement on high-end models, and

• potential end-of-lease fees.

However, leasing electric vehicles might be a good option. Recent price cuts by Tesla and Ford (for instance) to boost sales caused the value of those electric cars and trucks to drop significantly, negatively impacting those who purchased but not those who leased. Additionally, a current tax code loophole allows dealers to pass on some or all of the $7,500 federal tax credit for electric vehicles to lessees. This can be particularly beneficial compared to purchasing, where some buyers may not qualify for the full credit due to restrictions on the car’s origin, price, or the buyer’s income.

Generally, the most cost-effective strategy long-term is buying and holding a car until repair costs outweigh its value. But if frequent updates or budget constraints guide you, leasing could make sense, especially if you negotiate a bit. You can always negotiate the lease term or ask for a lower interest rate (also known as the “money factor”).

The Essentials of Car Insurance - Vianca Tabuena, CFP®

When it comes to car ownership, insurance isn’t just another item on the checklist, it’s your financial shield on and off the road. Here’s what you need to keep in mind to navigate the insurance landscape with confidence:

• Insurance Before Ignition: Don’t hit the road uninsured, whether it’s a new car or a private purchase. It’s not just about safety. It’s the law.

• Understanding Your Coverage: Car insurance offers different types of protection:

o   Liability Coverage (Required): Every state mandates minimum liability coverage. This protects others and their property if you’re at fault in an accident, but it typically won’t cover damage to your own car. Minimums likely won’t be enough. See more about that below under Extra Protection.

o   Optional Coverages: Beyond liability, consider these optional coverages:

§  Comprehensive: Protects your car from non-collision incidents like theft, vandalism, or weather events. This is recommended at least in in high-risk areas.

§  Collision: Pays to repair or replace your car after a collision. Consider your car’s value when deciding on this option.

• Balancing Coverage and Cost: Consider your situation. Let’s say your car is valued at $50,000. To balance protection with affordability, you could choose a higher deductible (say, $1,000). This lowers your premium but means you’ll pay more out-of-pocket if you need repairs. Choose the highest deductible you can comfortably afford.

• Extra Protection in the form of an Umbrella Policy: For added security, consider an umbrella policy. Umbrella policies offer substantial additional coverage at a lower cost. They kick in when your car insurance reaches its limit (generally only $300,000 of underlying liability coverage is needed), safeguarding your assets from lawsuits exceeding your standard policy. This is especially valuable for families with young drivers, who statistically pose a higher risk. An umbrella policy provides both potential preservation of assets and peace of mind, knowing you’re financially protected even in unforeseen circumstances.

Avoid the Pitfalls - Jon Strauss, CFP®

When entering the realm of car purchasing, a savvy buyer’s mantra should be caution and comprehension. Steering away from common missteps can save you both money and future headaches. Focusing on what to avoid can be just as crucial as knowing the right steps to take. Here are the pitfalls to steer clear of for a smooth journey to your new car.

• Go in prepared: Never enter a dealership without understanding the car’s true value. This includes knowing the sticker price, MSRP, and especially the dealer’s invoice price. Doing this can give you the upper hand in negotiations. Avoid accepting the listed price without comparison shopping, as prices can fluctuate between dealerships.

• Avoid impulse buying: Don’t visit the dealership at peak times. Shopping at the end of the month might give you an edge with eager-to-sell sales teams.

• Don’t focus solely on monthly payments: Ensure you’re getting a transparent total vehicle cost to avoid the unpleasant surprise of hidden fees.

• Don’t skip research on rebates: Never ignore available rebates and incentives that could lower your costs; do your research before you enter the showroom.

• Don’t ignore total ownership costs: Don’t just look at the purchase price; consider all long-term ownership costs, such as maintenance, insurance, and fuel economy.

• Avoid unnecessary add-ons: Don’t be persuaded to pay for extra features or extended warranties without assessing their true value and necessity.

• Avoid High-Pressure Sales: Don’t make decisions under pressure; give yourself the space and time to make an informed choice. You can always walk away (in fact, doing so may help your negotiating position).

• Don’t assume CarMax is better: Sometimes negotiation and dealing with the hassle of the process can actually lead to better savings.

If you are preparing to buy a new (or new to you) car, we urge you to reach out to any member of the WEIL Advisory Team to run through the nuts and bolts of the buying process, including running estimates on monthly payments, how much to put down (if you’re financing), and to review your insurance coverage. Buying a car is a major financial decision and we are here to assist (think of us as the AAA of your financial life, here to provide “roadside assistance” along your journey).  

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