What's the Best Way to Get a New Car?

Dear Carrie,

I need a new car. My current car is nine years old and on its last legs. I bought it used and was going to do the same thing this time around, but I’m also tempted by a new car because of the safety features. My budget is pretty tight though, so I’m not sure if I can even afford a new car. Any advice?

—A Reader

No matter how you look at it, getting a new car is both expensive and confusing. Expensive in part because of supply shortages for new and used vehicles. The average new car now costs nearly $40,000 (yes, that’s right). And confusing because once you have a good sense of the type of car you want, you still have to figure out the best way to pay for it.

Used or new? Purchase or lease? Purchase outright or finance over time? These are complicated decisions, with lots of variables to consider. But it’s worth it to proceed carefully because your decision will have a big impact not only on your immediate out-of-pocket cost, but also on your monthly budget and ability to fund other important goals.

Before you sign on the dotted line, it’s critical to understand that your costs are more than just the purchase price. The total costs of owning and operating an automobile include fuel, maintenance, repairs, tires, insurance, license, registration and taxes, and potentially financing costs. 

And money doesn’t necessarily tell the whole story. Some people value cars more than others. For them, owning a newer or fancier car is worth sacrificing in other areas. Like so many other purchasing decisions, selecting a car comes down to a mix of financial as well as non-financial criteria. Let’s take a look at your major decision points and hopefully steer you in the right direction.

Used versus new

Whether buying used or new is “better” depends on your situation. From a pure cost perspective, paying cash for a gently used two- to three-year-old vehicle and driving it for several years is a pretty sensible strategy.

This is due in large part to depreciation, or the reduction in resale value over time. In fact, depreciation is one of biggest expenses when buying a new car.

The particulars vary depending on a car’s make and model, but in general, new cars depreciate quickly (often more than 20 percent in year one), then taper down after the first three years. In contrast, used cars generally don’t decline in value as fast.

On the other hand, newer cars tend to be safer, break down less often, and be more fuel efficient (or don’t use fuel at all in the case of electric vehicles). A used car may be cheaper up front but may require more repairs not covered by warranty. Financing deals are also better for new cars (lower interest rates) than for used cars.

In other words, there's no one-size-fits-all answer. The best advice I can give you is to look beyond the initial purchase price and focus instead on the total costs of owning the car for several years.

Buying versus leasing

Nearly one-third of individuals lease these days, primarily because leasing gives you access to a newer or nicer car that you may not otherwise be able to afford.

The way I think of leasing is that you’re paying to drive the car, not own it. It can be a good option for those who can afford it and are okay with returning the car (or buying it) when the lease is up.

That said, the longer you plan to be in the vehicle and the more you drive, the more it makes sense to buy. Over time, the cost of leasing several cars will likely exceed the purchase price of a new or used car. Leasing can also lead you to spend more money on an expensive car rather than getting something more practical—and saving the difference.

Financing

Paying cash for a car isn’t practical for most households. The average amount financed for a new car is about $34,000; nearly $21,000 for a used car. Average monthly car payments are about $550 for a new car and $400 for a used car.

Low interest rates and auto manufacturer’s aggressive efforts to improve sales have led to increased offers of 72- and 84-month financing. These long commitments can dramatically bring down monthly payments, but it worries me that people are thinking more about a monthly payment rather than the total cost of ownership. You can quickly wind up upside down (where a car is worth less than you owe on it) leaving you with years left to pay on an unwanted vehicle that isn’t worth much.

New or used, if you’re financing a purchase try to follow these guidelines:

• The best financing deals go to people with the best credit scores. Get a free copy of your credit report at annualcreditreport.com. If your credit score has a few dings, take steps to improve it before you seek financing.
• Shop around and get pre-approved. You can check with the dealer, but you might also want to check with your credit union or local bank. Concentrating your applications in a short period of time can minimize the effect on your credit score.
• Avoid going out more than 36-60 months. A longer contract may have lower monthly payments, but your total cost will almost always be higher.
• Put at least 10-20 percent down. The ideal down payment wouldn't drain your emergency savings but would be big enough to help you save money on interest since you’re borrowing less. And keep in mind that a trade-in can serve as your down payment if it has enough value.
• Avoid rolling over payments from your current car to your next car. A dealer may present this as an easy solution, but it’s a bad start for a new loan.

A word of caution: The amount you qualify to borrow may be more than what you can really afford when you consider all your financial goals. When you borrow, it’s not just money that you’re borrowing from a bank. In a way, you’re borrowing from your future. Take time to think hard about this before you sign the dotted line on any loan.

Putting all the pieces together

Just like there’s no “one” car for every person, there isn’t one best way to buy a car. Your financial situation, goals and priorities all play a role. So do some soul-searching, and crunch your numbers carefully. If you understand the total costs of ownership, and how the purchase will impact other areas of your life, you’re well on your way to making the best decision.

Have a personal finance question? Email us at askcarrie@schwab.com. Carrie cannot respond to questions directly, but your topic may be considered for a future article. For Schwab account questions and general inquiries, contact Schwab.