This is an excerpt from Matthew Brandeburg’s new book: Financial Planning for your first job.
Buying a new car or a new home can be an expensive and overwhelming experience. It’s easy for judgment to become clouded as price negotiations end and financing arrangements begin. It’s during this time that first-time employee’s face one of their most challenging decisions—buy or lease? The buy or lease decision depends on many different factors and it’s a decision you can’t afford to get wrong. The long-term effects on your credit score, balance sheet, and bank account are too important to take this decision lightly. This chapter will provide the factors you’ll need to consider in order to make an intelligent decision and continue on your path to financial independence.
PART 1: BUY OR LEASE A CAR
1. Higher monthly payments
2. Limited warranty
3. Some resale value
1. Lower monthly payments
2. Almost always under warranty
3. No resale value
Factors to consider:
How long do you plan to drive the car? Short time frames of five years or less favor leasing.
How many miles do you plan to drive each year? Most car leases allow you to drive between 12,000 and 20,000 miles per year. If you exceed the limit, you’ll be charged for each additional mile you drive. The penalty for exceeding the mileage limit is typically $0.15 to $0.25 per additional mile, but varies depending on the lease. If you plan to drive your car more than the allotted number of miles, you should consider buying.
Be cautious of lease ads that offer unusually low mileage limits, such as 7,500 to 10,000 miles per year. Although your quoted monthly payment may be lower, you’ll be hit with large penalties if you exceed the mileage limit, which cancels out any potential benefit. When deciding between buying or leasing a car, remember the monthly payment alone is not always a good measure.
How much car can you afford?
You should have the sticker price of your new car already saved up in a checking or savings account before you buy or lease. Although you don’t necessarily want to pay cash for your new car, you need to have the option available. Otherwise, you’ll be buying more car than you can afford and relying on future income and investment earnings to make your monthly payments. This is a quick way to damage your credit score and dig yourself into debt.
Whether you’re buying or leasing, consider the amount of money you initially want to put down for your new car. Some dealers require very little at inception or nothing at all, but this may not always be to your advantage. You’ll have to factor in the additional interest you’ll have to pay over the life of the loan if you make only a small down payment. Use the free down payment calculator at www.bankrate.com/auto to determine your ideal down payment amount.
If you need to finance your new car by taking out a loan, apply through your bank, credit union, or mortgage provider before applying through the car dealership. Compare the interest rates offered by each company and select the one with the lowest rate. You’ll find that companies will be willing to offer loans with more favorable terms if you’re already doing business with them. Why? Because they can see first-hand what kind of customer you are without having to rely solely on your credit report. They’re also afraid of losing your business to their competitors, which increases your bargaining power. Keep in mind your interest rate will depend, to some degree, on the length of your loan. You can expect to pay a lower interest rate for a shorter loan (thirty-six months or less) than you would for a longer loan.
Car Buying Tips
1. Make a list of the makes and models you’re interested in along with the features you want before you visit the car dealership. Be as specific as possible.
2. Narrow down your search to a few cars, but don’t have your heart set on just one.
3. When you discuss price with the car dealer, ask for a firm quote in writing.
PART 2: BUY OR RENT A HOME
1. Making a down payment and paying closing costs
2. Monthly mortgage payment
3. Property taxes
4. Homeowner’s insurance
5. Maintenance and repair costs
6. Potential for borrowing through an equity line or equity loan
7. Tax deductions for mortgage interest and property taxes
8. The gain on the sale of your home will be excluded up to $250,000 if you’re single or $500,000 if you’re married.
1. Making a security deposit
2. Monthly rent payment
3. No property taxes
4. Renter’s insurance
5. Free maintenance and repairs
6. No potential for borrowing through an equity line or equity loan
7. No tax deductions for mortgage payments or property taxes because none are paid
8. No resale value
Factors to consider:
How long do you plan to live in your home? Short time frames of five years or less favor renting.
Can you afford the monthly mortgage payment for a fifteen-year or thirty-year fixed rate mortgage? You should avoid adjustable rate mortgages (ARMs) because the interest rate will change over the life of the mortgage depending on market conditions. The problem with ARMs is that borrowers don’t know what their interest rate will adjust to until it’s often too late to lock in a better rate. ARMs were partly responsible for the recent housing crisis, because as interest rates adjusted higher, mortgage payments suddenly became too expensive, resulting in delinquent payments and foreclosures. Fixed rate mortgages, on the other hand, are much safer because they allow borrowers to lock in interest rates that never change. If you can’t afford the monthly mortgage payment for a fifteen-year or thirty-year fixed rate mortgage, then you may need to rent.
Make sure you understand how expensive home ownership can be. The true cost of home ownership is estimated to be 1 percent to 1.50 percent of your home’s value per month. This includes the mortgage payment, taxes, and maintenance costs.
Consider your ability to meet the down payment requirement. You should be prepared to put down at least 20 percent of your home’s purchase price as a down payment.
Don’t forget to take into consideration non-financial factors, too. Is it important to you that you raise your family in a home you own instead of an apartment you rent? Is there a particular neighborhood you have your heart set on that you can only move into if you buy? Consider similar questions so your family can make the best overall decision. But a few words of caution: Make sure your final decision is not based purely on emotion. It needs to make good financial sense, too.
Whether buying or renting, make sure you address the following questions before committing to a property:
1. What’s your commuting distance to work?
2. What’s the quality of the general public services in the community?
3. Are there available recreation facilities nearby?
4. What’s the quality of the local public school system?
5. What are the latest crime statistics for the community?
6. What’s the overall quality of life in the community?
Matthew Brandeburg, CFP® is the author of the book Financial Planning For Your First Job, available at www.amazon.com. His book teaches young adults how to manage their money and take charge of their financial lives. He has seven years of financial planning experience and runs his own business, Bridgeway Financial Group, LLC, based in Columbus, Ohio.