Financial Planning for April 2005

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Spending Your Refund on a New Car?
Are you sure that's wise?


The following article is not intended to induce the reader into purchasing, leasing or "borrowing" a new vehicle. Nor is it intended to suggest that you will receive a refund on your taxes, and even if you do, this article is certainly not trying to tell you if you should or should not spend said refund. Finally, this article does not and will not promote the acquisition of one make of vehicle over another. Any similarities between the examples herein and actual vehicles or transactions is purely coincidental. In short - it's just an article and the numbers came out of thin cyber air.


So, you filed your income tax and are expecting a big refund. For what do you plan to use the refund? Will you use it as a down payment on a new car or truck? Perhaps you should get that high definition TV you've been admiring or maybe, just maybe, you plan to put it into your rainy day savings fund.

If you believe all the commercials on television and in the papers, now is the time to take the whole thing and blow it on a new absolutely gotta-have-something-or-other. Part of me likes this idea as it helps spur economic growth. Part of me wants the money locked into your savings or investment account, which also helps economic growth by providing a source of capital. You, on the other hand, don't really care what I think. You have been driving that 4X4 pickup for ten years and you want a new 4X4 SUV to haul the kids in and now, with that $5,000 refund coming your way, you are ready for a trip to the auto dealership.

Hey, it is your money. Spend it any way you like. I really don't care how you spend your money, as long as you use it wisely. But what is the wise thing to do when acquiring a new vehicle. Should you pay for the vehicle with a $5,000 down payment and a loan over the next 5 years? Some friends of yours are driving a brand new SUV (It just happens to be the exact vehicle you want) that they leased and it is not costing all that much. Maybe, you should lease. What's the right thing to do for you? In the following paragraphs, we will discuss the answers to that question, breaking the considerations down between financial and emotional.


First, let's take a look at only numbers. Here are our assumptions:

Vehicle Nice SUV
Purchase price $48,465
Interest rate 6.00%
Lease/Loan term 36 months
Sales/use tax rate 6.00%
Residual value $32,800
Down payment (purchase only) $5,000
Leasing fee $500

Using the above parameters and running the numbers, you will find the lease payment totals to 681.90; the purchase/payoff payments would be $1,410.75. So far, it's looking like the lease is winning. But when you look at the raw data for the entire period of the lease, or loan, a different picture emerges. In essence, overall cost to purchase the SUV is less under the purchase scenario ($55,787.12) than the lease option ($57,348.34). This is reasonable on a lease term that approximates the term of the purchase loan, but it is not necessarily the norm. Generally, the shorter the lease term, the more attractive the lease is.

Ok, now that we have the answers on cost, is it time to head to the dealership to strike a deal? Yeah, that's right - it's not time yet. What about long-term costs of owning versus leasing the auto? One of the very nice aspects of leasing an automobile, assuming you change vehicles every two to three years, is that you are never out of warranty - assuming you choose the right lease term. Pegging the term of a lease to the length of automobile's warranty will keep you from worrying about repair costs. Since the leased auto is always in warranty, the repairs are on the manufacturer, not you. On the other hand, holding onto that truck you got rid of to buy the new SUV could be a nightmare. Have you ever replaced a transmission?

Another positive to leasing is the up-front payments are less than the typical vehicle. Yes there are zero down payment loans, but many times these payments cost you in terms of rate and automobile purchase price. You might just be able to save a little of your refund from the down payment monster.

Last, but certainly far from least in the financial area, is the simple fact that under a lease you keep the car only for the term of the lease. Ultimately, the vehicle belongs to a leasing company and at the end of the lease, the leasing company wants it back. If you purchase the vehicle, you...well...own the SUV and do not have to return it to another owner.

What gives you a good feeling?

Some of the financial considerations dovetail directly into emotional ones. For example, let's look at our example. Under the purchase plan, once you make the final payment, you own the car and can keep it forever. If you are the kind of person who believes you need to put hundreds of thousands of miles on a vehicle to justify its use, Purchasing is the way to go. On the other hand, if you like driving a new car every two to three years, and you like the repair charge to stay a cost of the manufacturer, Lease may be you're best bet.

How hard are you on your car? At the end of a loan, no one's going to come to you and ask why there are dents on the hood, or holes in the upholstery. If you have little children in your family, there is a good chance the purchase should be the way to go. Little children have a way of changing the interior of your car (not always a good thing) and they don't care what condition your car is in when it gets to the end of a lease. You need to consider whether you will be able to keep the car in a good state without causing excessive wear and tear.

Do you drive a lot? If you want to be the one who drives your children to school and then run numerous errands afterward, expect to rack up 20,000 plus miles in a year. Since that kind of mileage can quickly devalue a vehicle, you might not be able to return the car which meets the residual value at the end of the lease. In addition, leases have an allowance for a normal amount of mileage during their terms. It is very expensive if you exceed those mileage allowances.


Back to our first question - how you are going to spend your refund. Since you need that new car, will you use the $5,000 for a down payment or will you keep it and lease a vehicle? The answer to this question is in your hands, but I hope this article has given you a few things to consider. Let us know if you need help in making the decision.

Have a happy April.


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