The Used-Car Option
In the event that John decides to buy secondhand, what would be the payment structure? The sticker price would be lower than it would be on a new car, and the credit score required to qualify for an auto loan would be lower as well, saving you money right away. In the event that John follows the averages once again, the amount financed for the used automobile he selected would be $22,623. The down payment would be little more than 10% of the purchase price ($2,660). The monthly payment would be $416, and it would take about 68 months to completely pay off the loan in full. The interest rate on a used automobile loan would be around 3 percentage points more than the interest rate on a new car loan. However, this is standard practice in the used-car financing industry.
The cost of gasoline would be almost the same. Because the automobile is being utilized, the insurance premiums would be slightly lower. The insurance savings, on the other hand, would almost certainly be outweighed by the increased maintenance costs associated with an older car. In this case, let us call it a wash and use the same estimate as for a new car: 8 percent of take-home income for insurance and gasoline.
A used automobile would cost John $676 per month, or around 21 percent of his monthly take-home salary, assuming that he purchased it. On the surface, this purchase appears to be the most cost-effective because John is taking out a smaller credit. However, this is not the case.
In order to pay off the debt, however, it would take five and a half years, by which time the vehicle would be eight or nine years old. How long do you think John will be willing to drive it? It’s important to keep this in mind while choosing a long loan term because the whole objective of financing is to eventually be free of auto payments. Let’s also consider the possibility that John may purchase another SUV as soon as the previous one is paid off, in which case he may as well be leasing.
The Lease Option is a type of lease arrangement.
In 2019, a three-year lease had a monthly payment of $465 and an average down payment of $2,646, with a monthly payment of $465. Always keep in mind that these averages are high since many of the leased vehicles are high-end luxury vehicles (think BMW, Mercedes-Benz and the like). Because John is not searching for a high-end car, he should be able to purchase a midsize SUV for around $400 per month and approximately $1,800 down payment. One significant distinction, though, is that John would be required to limit his driving to around 12,000 miles per year, which is a usual mileage limit for leasing bargains that are promoted. According to our calculations, adding more miles would cost an additional $25 per month.
John’s lease payment would be a more manageable $400 per month, or 12.7 percent of his take-home earnings, which he could more easily afford. With gasoline and insurance expenses accounting for 7% of John’s take-home salary, he would spend around $660 per month on this vehicle, which represents approximately 21% of his monthly income. In terms of total car expenditures, that’s a tad more than our recommended 20 percent.
In this case, John would be paying far less per month to lease than he would to purchase. Because of the lower down payment, John would also have a bit more money in the bank than he would otherwise have. John, on the other hand, would be restricted in the number of miles he could drive (without incurring a penalty) and would have to start the procedure all over again when his lease expires in three years.