Before buying a vehicle, you should know how you will pay for it. In fact, it is best to know your payment method by the time you are performing test-drives and hunting for quotes. At this stage in the car buying process, you should have a short list of vehicles you are most likely to buy and an estimated car budget. If you do, then it is time to select your payment method.
There are three basic payment types: cash, finance and lease. The first two let you buy a vehicle, while the latter allows you to borrow it for a certain period of time. While it may sound like a simple choice between A, B and C, there are several nuances to each option. Here is everything you need to know about them.
The most popular car payment option by far is financing because it lets you borrow the money you need to cover a vehicle’s full price. By settling for this option, you slowly pay off the amount plus interest on a monthly basis.
A typical financing term lasts for about five years or 60 months, but some are known to last for up to eight years or 96 months. The longer the term, the lower the monthly payments. However, a long financing term also equals to more interest and a significant loss in value by the time the payments are done. The latter is known as depreciation. So, if you decide to sell the vehicle at some point, these factors may greatly reduce your potential return.
An average car depreciates about 60 per cent of its initial cost after five years. This means that by the time you are done paying off an even longer loan, the vehicle will be worth only a fraction of its cost. If you try to sell the car before the loan is finished, you may run into something called “negative equity” – or owing more than the car is worth. It is a direct result of a loss in value, which means that longer loan terms increase the risk of its occurrence.
There are two places where a car buyer can obtain vehicle financing – from the dealership where the vehicle is being purchased or a financial institution like a bank or credit union. By opting for dealership financing, you can benefit from related incentives. Zero-per-cent financing is one of them, which is an offer to waive interest for a certain period of time. However, in many cases, the proposal tends to result in higher interest rates later on.
Obtaining a loan from a financial institution can yield benefits of its own, such as lower interest rates and various convenience features, including the ability to check the status of your payment through an existing account. Most lenders will ask you for a down payment – regardless of whether they are a dealership or a financial institution. The minimum amount tends to be 10 per cent of the purchase price, but you are allowed to increase it if you want your monthly payments to be lower or your term length shorter.
The best way to determine the most viable financing option is by comparing offers from dealerships to that of a financial institution. You may even examine the offers from multiple financial institutions to increase your chances of finding the best deal.
Cash is the most straightforward payment method a dealer can offer since it lets you pay the full price immediately – the way one would with a loaf of bread or a pair of pants. As a result, the issue with this method is obvious – if you do not have enough money on your bank account to pay for the vehicle, then you cannot buy it.
However, it is possible to opt for a cash purchase even if you do not have enough money to pay for a vehicle upfront. You can accomplish this by going to the financial institution of your choice and asking them to finance your cash purchase. This way, the dealer is paid in full, while you still obtain a loan.
One of the main reasons why anyone would want to borrow money for a cash purchase is to benefit from cash-specific incentives and/or rebates, which are sometimes better than those offered with other payment options.
A lease is the least popular payment option because it does not let you buy a car, forcing you to rent it instead. The process is actually very similar to financing, meaning that it requires a down payment (or deposit), followed by monthly payments until the lease is done. However, unlike a loan, a lease does not require you to cover the full price. Instead, lenders ask you to cover the amount the vehicle will presumably lose as it depreciates. So, if your lease term is three years and the vehicle is predicted to be worth 40 per cent of its initial value by that point, then your deposit and monthly payments will have to cover 60 per cent of the price.
Because of this, lease payments tend to be lower than loan payments, which makes leasing a more affordable option. You also do not have to sell or trade in a vehicle once the lease is over since all you need to do is return the vehicle to the dealer and replace it with a new one.
There are also a few significant downsides to leasing. One of them is the fact that most lenders will not let you keep a car longer than three years, meaning that you have to commit to a new one regularly. Another possibly deal-breaking flaw is limited annual mileage, which can significantly restrict your driving habits – and going over the limit can cost a lot of money.
Leasing is ideal for people who want to be able to afford a new vehicle every few years. If you are not okay with the aforementioned restrictions, then financing may be a better option for you.
There is no right or wrong way to go about choosing a payment option. Ultimately, your selection should depend on your budget and personal preferences. For instance, if you do not have enough money to afford a cash purchase, then you should go for either financing or leasing. If, on top of that, you want to actually own a vehicle, then financing is clearly your best option. However, if you can benefit from lower monthly payments, then it may be worth checking out a lease deal instead.
Once you have your payment method picked, test-drive the vehicles on your short list and obtain quotes from the dealers. After that, choose your car and head over to the appropriate dealership to negotiate its price.