The Used-Car Option
What would the payment look like if Chris were to buy used? For starters, the sticker price would be less expensive and there would be a lower threshold of credit needed for financing the auto loan. Assuming again that Chris goes with the averages, the amount financed for the used vehicle Chris chose would be $21,215. The down payment would be just over 10 percent ($2,480). The monthly payment would be $384 and it would take about 67 months to pay it off. The used-car loan would have an interest rate roughly 3 percentage points higher than that of a new-car loan. But that's typical for used-car lending.
Fuel costs would be roughly the same. Insurance would be slightly less because the car is used. This insurance savings, though, would likely be offset by the added maintenance that comes with an older vehicle. Let's call it a wash and assume the same estimate as for a new car: 7 percent of take-home pay for insurance and fuel.
By buying a used vehicle, Chris would be spending $644 a month, or about 17.5 percent of monthly take-home pay. On its face, this would seem to be the most cost-effective purchase since Chris is taking out a smaller loan.
But it would take five and a half years to pay off the loan amount, at which point the car would be 8 or 9 years old. How much longer will Chris want to drive it? The whole point of financing is to eventually be free of a car payment, and if Chris buys another SUV as soon as the old one is paid off, Chris might as well be leasing, so let's look at that.
The Lease Option
A three-year lease in 2017 had a monthly payment of $447 and an average down payment of $2,486. Keep in mind that these averages are high because many leased cars are luxury models (think BMW, Mercedes-Benz and the like). Since Chris is looking for a non-luxury SUV, he can easily find one for the same money down and $100 less per month than the luxury-vehicle average. One major difference, however, is that Chris would have to limit driving to 10,000 miles per year, which is a common mileage limit for advertised lease specials. Adding more miles would cost an extra $25 per month, by our estimates.
Chris' lease payment would be an easier-to-afford $345 per month — less than 10 percent of his take-home pay. When we factor in 7 percent of take-home pay for fuel and insurance costs, Chris would be spending about $605 per month on this car, which would be about 16.4 percent of his monthly income. That's a good fit for our 17 percent budget for a leased car.
In this scenario, Chris would be paying much less per month to lease than to buy. Chris would also have more in the bank because of the smaller down payment. On the other hand, Chris would be limited on miles driven and would have to start the process over in three years when the lease is up.
Examine Your Buying Patterns
In addition to the formula for car affordability, recognizing your own car-buying habits, good and bad, can offer clues to the best strategy for you.
For example, are you someone who buys a car, pays it off, and then keeps it for a few years? Buying a new car would work for you: You have a track record of shopping within your means, finishing off the loan, and going payment-free for a while. That's smart.
Do you get bored with a car after a few years? Then leasing is your best bet. What good is it to take out a six-year loan if you're going to trade in the vehicle during the fourth or fifth year? You'll likely owe more than the car is worth and will have to roll that balance into the next loan. You'd be better off leasing and paying less per month. Leasing also lets you get a nicer car for less money.
Finally, are you trying to make the most financially sound decision possible? Then buy a lightly used car, pay it off, and keep it for many years. The first owner takes the depreciation hit, and you'll have a car that's new enough to avoid major repairs for a while.
What's the Best Option?
There's a case to be made for each of these approaches to affordability. It is essential to recognize your car-buying history, and if you do commit to a long-term loan, make sure you drive the vehicle for at least a few years after it is paid off.
In the end, the best car-buying scenario will be one that takes into account your bills and other financial responsibilities. If it's a stretch for you to buy now, consider saving up a bit more and revisit shopping at a better time. The most important things are to know your budget and remember that there's more to owning a car than just that monthly payment.