A few weeks ago, we wrote about how much house you can afford. This week we are covering the other biggest item in most family’s budgets, automobile expenses.
The average American family spends 13-17% of their household income on transportation, which is mostly automobile expenses. This is more than most families can comfortably afford. As a result, other financial priorities such as saving for the future and insurance coverage get crowded out.
One of the best pieces of financial advice:
One of the best pieces of financial advice you can give to an aspiring millionaire is “Never borrow money for a depreciating asset.” It is very unlikely that you will overspend on a car, if you are paying cash. It is not as easy to justify paying $50,000 vs $30,000 in a lump sum for a new car, as it is to justify a monthly payment of $750 vs. $500.
Another big determinant of automobile expenses is wheter you buy or lease:
Let’s look at an example, which I borrowed from Sara Silverman at Businessinsider.com. A new Jeep Grand Cherokee sells for approximately $29,395. You can buy it and get a 36 month car loan at current interest rates with a down payment of $5,879 and a monthly payment of $754. Leasing the same vehicle requires less than half as much for a down payment ($2,499) and only $485 per month. Lease payments are 23% lower on average than payments on car loans, which is one reason that a record number of people are leasing.
Leasing is less expensive in the short-term, but more expensive long-term:
As you can see, leasing requires less out-of-pocket automobile expenses in the short-term. However, let’s suppose you buy your car and keep it for 11 years (the average age of a car on the road today). That means you would have eight years of no car payments. You would also receive some of your money back when you sell the car, which can then be used for the down payment on your next purchase. Alternatively, you will always have a payment if you lease.
It makes sense that leasing is more expensive in the long run because you are only driving the vehicle for the first 2-3 years when it is depreciating (losing value) the fastest. Overall automobile expenses are higher in the long run if you lease. The wealth-maximizing strategy, as it relates to automobile expenses, is buying the car and driving it until the wheels fall off.
Leasing makes sense if…
I always buy my cars (and pay cash), but leasing can make sense in certain situations; such as, if you are cash poor, you are going to get a new car every 2-3 years, can use the car for business purposes and thereby write off all or part of your lease payment, and drive less than 12,000 miles a year. Many people like the convenience of leasing, having a car that is always relatively new, and a car that is always under warrantly. It is also important that you take great care of the vehicle if you intend to lease. Otherwise, the dealership will charge you for any little ding or damage when you return the car at the end of the lease term.
Leasing may not be advisable if you have young kids who have been known to spill stuff in your car or walk on the seats (even after being told not to) 🙂