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One of the most common questions I get from my clients is whether they should buy or lease a car. And it makes sense — after buying your house, your car is one of your biggest monthly expenses.  

So should you buy or lease a car? 

It depends on several factors that are unique to you. In this episode, I discuss all these factors so you can make a smarter financial decision whether you lease or buy. Listen to the episode now. 

Show Highlights Include:

  • Why used cars are up 24% from June 2020 (and how this affects whether you should buy or lease your car) (3:17) 
  • The “3-year breakeven” strategy that helps you decide if it's cheaper to lease or buy the same exact car (4:45) 
  • The “Interest Rate Arbitrage” secret that can help you make more money from financing a car instead of paying cash (6:35) 
  • Why car dealerships make their money with extended warranties (and how to decide if you need an extended warranty or not) (11:10) 

To schedule your free retirement tracking meeting, specifically for first responders, head to http://pensionattention.com/ or call us at 805-409-8150.

Read Full Transcript

Welcome to Pension Attention, the best show for first responders who want to take control of their finances.

After advising Los Angeles city firefighters for over 12 years, financial advisor, Brad Barrett now shares how you can grow your wealth, build your legacy and enjoy a life of freedom. And now here's your host, Brad Barrett. [00:19.9]

Brad: Welcome to Pension Attention, the show for you, first responders who want more out of their deferred compensation and pension plan. My goal with this podcast is to reach you where you are. At whatever stage in your career, you are in, in order to provide my nearly 15 years of experience working with both active and retired service members on their investment and retirement planning. My team of fiduciary advisors here at One Capital Management are dedicated to ensuring you not only take control of your finances and build the life you deserve. Now to find out more about me or my advisor partner, or any one of our advisors here at One Capital Management, you can go to our website PensionAttention.com or you can give us a call. You can call us at (805) 409-8150. And before we get started on today's episode of Pension Attention, if you haven't already done so you can go to our website, which is again, PensionAttention.com and you can download and subscribe to the Pension Attention podcast right there on the website. You can also download anywhere you would otherwise download a podcast, whether that's the Google podcasts, Spotify, SoundCloud, or the apple app on your phone. And as you do, leave us a message, let us know what we're doing. Share the podcast, we'd love it to get out to more people that are within the stations on both the fire department and the police department. And again, if you liked the show, share it. If you don't like the show, I guess don't share it, so don't listen to me on that regard. [01:42.5]

But today's topic as I mentioned last week, we're gonna talk about something that really is probably one of the more common questions, probably top 10 questions I've seen in my nearly 20 years of being a financial advisor when it comes to both first responders and really anyone else that we do private wealth advising for. And that's regarding your car, whether you should buy, lease finance, what are the right options? What does it all mean? We're going to break that down today. [02:11.2]

All right, look, I'm just going to come out of the gate and say it. It really comes down to what type of owner you are. Do you like to hold onto your car for years or do you like to switch it out frequently? You probably see where I'm going with this, but that really is the start to this question around should I buy or lease a car? Do you drive a lot of miles? Do you dislike paying for comprehensive insurance? We'll talk about that today. How you answer some of those questions. I just mentioned has a lot to do with what type of owner of a car you are. So, for many people listening after buying your home, which is usually the biggest purchase in most people's lives. One of the next major purchase decisions and really expenses is a car. [02:56.0]

Now for many of us, that can be multiple cars in a lifetime for, it's not that many, again, back to the topic, it depends on what type of owner you are. The latest headlines in particular, as I was researching this topic, as I've discussed in studied for many, many years now, it actually came to an article. I was reading in the Wall Street Journal titled Buying a Car now is brutal. Talk about how the market for cars in particular nowadays has just been turned upside down, really due to lack of inventory and ultimately the parts availability and the transaction price of used cars in particular is up 24% from June, 2020. This data, again from the Wall Street Journal. [03:39.6]

Now I spoke about this a couple of weeks ago on our inflation podcast. And I brought up that one of the main areas happens to be cars that is supply chain, disruption has happened. So, it's just an interesting tidbit as we get into the conversation around cars of buying leasing new cars used cars, but it's interesting how much the prices of used cars in particular are up. So, if you think about it with really minimal deals to be had buying a car now appears to be more challenging than it was in the past. So, I digress a little bit, but it's an interesting point to be had when it comes to the historical question, I've been getting for nearly 20 years on car purchases. [04:19.2]

Now back to whether to lease or buy a car. Again, depends on your circumstances and preferences. I made a rough calculation a few years ago. I was having a discussion with a client and I always every year kind of go through the numbers, see what the interest rates are at. And I came to this conclusion, this is my own personal conclusion and I want to share that today. I have a couple of things I'm going to share with regards to specific suggestions as you look at that question between leasing or buying. But a couple of years ago, I came to the conclusion that whether you bought or leased the exact same car, you would likely break even at about the three-year mark. Before that point, you may spend less on a lease, but after that point, you tend to come out ahead by buying. Why? You might ask. [05:06.9]

Well, because the lease payments take into account, the big depreciation hit you experienced with any new car, which by the way, is the highest in the first two to three years. So, if you lease, you are still paying for that depreciation. So let me give you an example. If you buy a $50,000 car for cash after three years, you will be able to sell it for say $30,000. Again, I'm using a rough hypothetical based on normal economic circumstances based on depreciation for a $50,000 car. So, by the $50,000 car for cash after three years, you'll be able to sell it for let's say again, $30,000, which means you spent “$20,000” owning the car for those three years. If you lease the car. As the other example, your three years is worth of lease payments will likely be very close to the same $20,000 again, due to the depreciation factor. So, if you buy and keep the car longer than that, it continues to depreciate, but at a declining rate over time, again, the first two or three years has a higher depreciation. So, owning the same car for six years is then cheaper than leasing for six years. The breakeven point again is right around three years. So, one way to save is to buy a two- to three-year-old car that has already taken in the initial depreciation hit. So, keep it for seven, 10 years and hope the repairs aren't that expensive little life hack for you right there. [06:35.4]

So again, now the question comes into, do you want to pay cash or finance? Again, depending on where interest rates are, which right now they're pretty good. It may make sense to pay cash. If you have sufficient cash available, if you have say $50,000 sitting in cash earning 1%, but your loan would be at 6%, it may make financial sense to pay cash. Now, conversely, as I shared with many clients listening here, when it comes to car purchases or those who aren't clients who are thinking about this, or want to know more about it, you want to look at what's called interest rate arbitrage. If you have that same $50,000 that you would have otherwise put into a depreciating asset, which is a car, and let's say that car payment or that interest rate on the car payment was 1%. If you can go and put a portfolio around that $50,000 and make 2%, 3%, you end up winning because arbitrage is on your side. Now that's not a guarantee that you're going to make that each year, but you can reasonably assume that over a five- or seven-year finance period, you should be able to get a conservative portfolio to build that out, so, something to consider. Most people think that if they've hit the financial crescendo, if they will have having enough cash to just buy a car outright, that people will do it. [07:49.2]

I've had more conversations with those that most people would think are financially free at least from a monetary standpoint, that really look at it still from an interest rate, arbitrage perspective. They're going, why would I give someone my $50 an hour cash for a depreciating asset when I can relative to risk go and earn more than the 1% I'd pay on it. That's interest rate arbitrage, something to think about when it comes to, if you have that cash available to just, you know, buy the car outright. And again, if that in that example, the 50,000 is all you have in emergency savings. You again, may not want to tie up all those funds in a depreciating asset and prefer to go the financial route, especially if you're still working. So, another consideration would be the probability of you replacing that again, hypothetical $50,000 with new savings once it has been used to buy the car. So, some people are psychologically have a harder time paying themselves back than paying the bank. I'm going to say that again, because I see that often in many of you listening right now, this, you might fall into this camp. [08:53.5]

People psychologically have a harder time paying themselves back than paying the bank. Interest rates for new cars are usually lower than for used cars and often the dealer may offer a very low interest financing. Something people love, but at the same time, you might actually find that by buying the car outright, but also paying yourself back the payment that you would have been making back to yourself. People get a little bit less comfortable with that, but in many situations that might work. So, you notice in the first couple of minutes here and talking about this conversation, there's multiple ways to skin this cat. It really has to do with planning and going through it one-on-one with an advisor to see which is the right route for you. So again, if your $50,000 is invested in say the equity market and you expect maybe a 7% return or more over time, although markets can go either way, as we've talked about, you may prefer to finance and leave your money to grow back to the interest rate arbitrage perspective. So again, it depends on how you look at it. [09:47.7]

So, another important aspect for those listening that are retired is if your money is all in an IRA or other retirement account, taking out a $50,000 lump sum to buy a car may actually cost you way more than that because you have to pay taxes, right? So that $50,000 car might cost you $70,000. Once you factor in the taxes. And again, that actually may even push you into higher tax brackets and really want to consider that when you look at those that are retired and are having only assets that are tax deferred. [10:17.6]

Do you know how much you should be contributing to your deferred compensation plan? Are you getting the most out of your current investment options? Looking at entering or about to exit the DROP program? Go to www.pensionattention.com to find out how we can help. [10:33.2]

Okay. So, let's shift over for a second to the maintenance and depreciation costs. I'll be honest with you guys. I really wanted to go through this topic in its entirety. So, I'm going to go through all the categories I can think of, of nearly 20 years when looking at calculations, when it comes to the right answer of buying or leasing. So, if you're buying a car, you would want to check into what is covered under warranty and for how long. Anything not covered would be your responsibility and an extra expense so, know that. Now some warranties on new cars, they're not really worth the paper they're printed on to be honest, they're expensive mechanical systems that tend to give trouble or sometimes really not covered at all. And often, check this out, often the dealer will try and talk you into purchasing an extended warranty. [11:16.6]

I know from firsthand, from friends who own dealerships, that that's where money is made. I'm not saying it's a bad thing. I'm just saying each consumer should know that. Now should you buy an extended warranty is probably your next question. Okay. It's a gamble that works similar to insurance, but you would want to understand the types of repairs you are insuring against to make sure the coverage is worth it. They don't, again, cover everything. So, some warranties are expensive and it may make sense to just save the cash you would pay for the warranty in case the car does need repairs so, you're coming out of pocket. If you can't afford the repair, if you had a costly problem, then it may make more sense to get the warranty. Something you got to assess on the type of car you're getting and understanding the reliability of that car and then really filtering that into what you are comfortable with when it comes to your risk, whether you are self-insuring that or buying the warranty to insure that. [12:08.1]

Another point by the way to that is to consider is if you have an accident with a car you own, when you try to resell it, you're going to get a lower value for it, we all know that. Now some insurance policies offer coverage for this possibility, but before choosing a car, check out resale values for that type of car. So, when you are ready to sell, you'll have an idea on the future valuation. I was talking to my father-in-law over the weekend and he's notoriously for like 20 plus years, always had Toyota Tacomas. He like lives and breathes Toyota Tacomas. And as I was thinking about this subject last week, as I was writing for this episode, I was looking into what I just said, the resell values, those things, those things keep value. Now, to be fair, I am not promoting Toyota by any means, but I'm just telling you, if you do some research on specifically Toyota Tacomas, you will find that those things hold value significantly, just food for thought. So, in order to get a sense of how much a car costs, you can go to things like truecar.com or edmunds.com, they're all great tools, a truecar actually aggregates all the newer used cars in the area based upon factors that you can actually determine like your make year model, etc. I used some of those as I was going through my father-in-law's example of his Toyota Tacoma. [13:21.6]

Now most car dealers have some negotiating room as well, so just know that which really can be up to a couple thousand dollars, especially if a new model is coming out. So do your research before negotiating. All right so, let's shift over a little bit to leasing a car, some things to consider here. First and foremost, I think it's important to know the least commitment. So, if you tend to keep cars for a long time purchasing, maybe the way to go, as I mentioned a few minutes ago. But if the shiny new toy every few years is your thing. You might want to look into leasing. If you believe your circumstances, okay, may change, whether that's from a job for many of you, that probably won't be the case so much, but you know where I'm going this. Maybe it's a move, maybe it's travel, maybe you get to special duty and you have a car being for use. You're not spending as much miles on your car, all things to consider as you're looking at this. You know, you may want to look at how you're looking at a car as a lease option. And again, leasing provides a lot of flexibility since you're not committed to the car for more than, let's say two to four years. [14:24.1]

Also, you will likely be able to get more car for your money with a lease. That right there is one of the bigger enticements for leases, for many people. It's something that I talk about. And I want people to be very careful of that just because you can't on a monthly payment perspective, get a escalate versus let's say a Tahoe as an example, doesn't mean that's the right financial choice to be fair. Okay. So again, there's a, usually an upfront cost to leasing as well. So that amount due at signing, which typically is tax tag, title, maybe a down payment and you negotiate also delivery costs, potentially those are all examples. Upfront costs. The lump sum usually reduces your monthly payments and actually may be required depending on your credit as well. Some dealers offer zero down, but all this does is increase your monthly payments. Again, it's all a numbers game, a higher down payment means you your lower monthly payment and vice versa. So, to get an idea of what you're really paying each month on average may want to divide the down payment by the months of the lease. Quick hack there again, I'll say that again. You may want to when understanding what you're really paying each month on average divide the down payment by the months of the lease. [15:36.8]

Okay. Moving into maintenance and mileage. You're probably thinking Brad, this is way too detailed on a car for an investment advisor. And I want to tell you from experience, this is something I talk about probably once a month with clients. It comes up constantly all the time. So, I really wanted to be thorough for you guys. So, maintenance and mileage, many brands out there as you'll look have scheduled maintenance included, which to be honest, it can be quite convenient. However, there are also several coverages such as tire protection and dent and scratch insurance. By the way, those are three. I mentioned from personal experience that you can buy that will increase your actual lease payments. So most standard lease offers allow 10,000-mile limits per year. If you drive more than 10,000 miles, this will also increase your payments on the front end or really on the back end when you return the car, you'll be required to pay for extra miles. You can go to 12,000 or 15,000 miles per year, but again, you're just going to increase your lease payment. So, it's usually cheaper to pay for the miles before you return the car on a lease. And in some cases, there's actually a timeframe. You actually have to buy the extra miles three months before the end of the lease in some of these cases. So extra mileage can range from around 15 cents to 30 cents per mile. And that can add up fairly quickly if you think about it. [16:54.7]

Add 30 cents a mile, 3000 extra miles will cost you $900. So, if you drive more than 15,000 miles annually purchasing car again, maybe cheaper for you. Again, 10,000 is kind of the usual lease 12,000, you can do 15,000 miles at least, I've done that before because I wasn't driving that much. But if you go over that, you may want to look at the financing or the purchasing of it back to the top of the episode as well. And if you're driving 25,000 miles a year, this can get restrictive and expensive when it comes to leases. So again, assessing your mile, knowing what kind of owner you are, all questions leading into this to help you drive pun intended to your ultimate goal or decision on whether to buy or lease. Now, keep in mind on a purchase car, the increased mileage will fetch you a lower sales price when you're ready to sell anyway. So, you may look at that as an apples-to-apples comparison, depending again, your viewpoint there. [17:52.1]

Okay. Insurance costs. Leases also require full insurance coverage to protect you and the leasing company. So, if you want to pay for less insurance purchasing may actually be a better alternative. That's a little misnomer. Most people don't think that, but that is the truth. Additionally, lease cars usually have what's called gap insurance built in this pays the difference between what you owe and what your car is worth if it's stolen or totaled in an accident. Loans do not usually have this coverage, so you want to check with your insurance company to see if this is something they offer. It's a good point to note between buying and leasing okay. [18:29.0]

And lastly, something that gets brought up with a lot of clients and for many of you listening right now, this may not pertain to you being first responders, but there are tax benefits if you own your own business and can use lease payments or mileage allowance as a tax write-off, which is another factor to consider. So, if you have a side job as construction or roofing, or a lot of the side jobs, I know that a lot of my clients have, this may be an option for you. This is something you definitely want to talk with your accountant with, or a CPA with. If you don't have one of those, we can obviously help you with that through our network of accountants. But that's one of the last benefits to look at. It is there to be fair, but it really needs to be made sure it's used for the right reason. [19:12.5]

So, in sum buying or leasing, a car has a lot to do with the first question I mentioned at the top of the episode, what type of owner are you, do you like to hold on your car for years or switch it out frequently? Do you drive a lot of miles? Do you dislike paying for insurance or comprehensive insurance, that gap insurance I talked about? So how, again, you answer those steers you in the right direction, unintended. So again, I know that was thorough kind of in the weeds when it comes to the question of, Hey Brad, I was just wondering what you thought, man. I don't need you to go on a huge dissertation. Well, I know, but I think it was good to be able to go through all the angles to that question. Now you'll notice, I didn't necessarily answer your question. Why? Because it really does take a conversation of planning. I know that seems like a long-winded answer to that. But again, back to my comment around this being probably the second or third larger expenses that most people will pay for, it's worth a few minutes of your time to really figure out what's right for you, because you can read or Google something and talk through this and look on forums and talk to friends or family everyone's, this is one of those topics that everyone has a unique perspective as they look at what type of owner they are, or, they drive . You need to filter all that into your world and make sure it fits for you. And just word of caution on the lease aspect, I mentioned it earlier, but on the lease aspect, be careful of chasing the carrot of Ooh, man, that's a pretty cheap price to get a better car. [20:42.7]

I'm not saying don't do it. Just know that you're paying the upfront for that ahead of time in the first two or three years. The value on the purchasing of a car, again, break even being three years, right around six or seven is kind of where you start making money if you own a car longer than that. Because you still own the car, you have the value. It's a sellable asset, right? Even though it's a depreciating one, it will be sellable. Back to my father-in-law's example of his Toyota Tacoma, which he dearly loves. He can sell the Tacoma he's had for nearly 10 years for about $3,000, less than what he paid for it 10 years ago. That's crazy to me. That's store of value. So, you got to look at it from a perspective of what means more for you. There's many people I talk to who just really love luxury and convenience with a car. There's nothing wrong with that. So, make sure you find the car that fits for you. [21:32.4]

And if you want some more help with that, you can reach out with us, we'd happy to put a plan together for you as it relates to all of the topics when it comes to your finances of deferred comp plan, retirement investing, and even things like this. Because again, it is a large purchase. Don't downplay it. You can give us a call at (805) 409-8150 can also go to our website at PensionAttention.com and there you can set some time with myself or any one of our advisors to go through your specific goals and objectives from everything from your overall retirement plan to something that we talked about today of as simple as, should I buy or lease a car? [22:06.6]

So again, PensionAttention.com set some time with myself, Toby Rodriguez or any one of our advisors and seek that counsel because although it may seem like an easy answer, it really is something you should probably look through and make sure it works for exactly what your goals are when it comes to a large purchase or investment such as a car. I want to thank you for listening to Pension Attention today. Before acting on anything discussed today, remember speak with a financial advisor near you about your specific situation or again if you'd like our help, you can visit us at PensionAttention.com or give us a call (805) 409-8150. And until next week stay safe. [22:46.0]

The information in this podcast is educational and general in nature and does not take into consideration the listeners personal circumstances. Therefore, it is not intended to be a substitute for specific individualized, financial, legal, or tax advice.

To determine which strategies or investments may be suitable for you consult the appropriate qualified professional prior to making a final decision. [23:08.9]

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