Buying better than leasing if car is one you’ll keep

Question: Is it better to buy a car with cash, lease or loan?

Answer: Buying a car with cash upfront is the best but not the most realistic option for most consumers. Choosing whether to finance your car through a loan or lease all depends on your lifestyle, needs and desires.

If you enjoy having a shiny new car every two years, leasing may be an attractive option. You won’t have to go through the hassle of trading in your car, and luxury models can be available for lower monthly payments. However, leasing is more expensive in the long run, and you could incur additional charges for excessive mileage and/or wear-and-tear charges once the lease expires. Your monthly payments will never go toward building equity in a vehicle you own.

Owning your car makes the most financial sense if you plan to hold on to it in the long term. With a car loan, every monthly payment you make puts you one step closer to owning your vehicle. Once you’ve paid off your loan, you don’t need to worry about making payments each month, which frees up your funds to build your savings or pay off other debts. You also have the flexibility to easily make modifications or sell the car whenever you want.

Q: What is an average annual percentage rate, or APR, when leasing or purchasing a car with an auto loan?

A: For both leases and loans, rates are based on your credit score — a higher credit score means you are eligible for a lower interest rate. On average, auto loan rates should be between 3.5 percent and 4 percent for a five-year loan if your credit score is above 750.

For car leasing, the finance charge that you pay is called a “money factor,” which is different from an APR. The money factor is expressed as a smaller number (such as 0.0020) and shouldn’t be taken as an extremely low financing rate. Multiply the money factor by 2,400 to receive a value equivalent to an APR.

Q: What is an average amount of time to pay off a vehicle?

A: Nationally, the average length of a new-car loan is 67 months, a little less than six years. Auto loan terms usually range from five to seven years. Longer-term loans keep monthly payments lower, which makes purchasing a new car more affordable for the average consumer — but you do end up paying more interest in the long run. Hawaii State FCU (Federal Credit Union) offers low interest rates and favorable terms up to seven years.

Q: What does it mean to be upside down on your car loan?

A: Being “upside down” on a car loan means the amount you owe is more than the value of the car. This is a common situation that many consumers find themselves in if they want to trade in their car after only a few years. Cars depreciate in value from the moment they leave the dealership, so if you don’t make a down payment, you will be upside down as soon as you take your new car home.

Q:Is it ever advisable to try to trade in your car when you are upside down on the loan?

A: Your car will lose quite a bit of value in its first few years, and your monthly payments likely will not keep pace with the rate of depreciation. Consumers face a negative equity situation until they make enough monthly payments to tip the scales in their favor — meaning the amount left on the loan is less than what the car is worth. This usually happens a few years into the loan.

If you are upside down on your loan, trading in your vehicle wouldn’t make much sense financially. If you don’t have sufficient cash to pay the deficit, you would have to roll over the balance of your loan into your new car loan. Although you may be offered a comparable monthly payment, the loan will be over a longer period of time. You’ll owe a lot more than the new car is worth from the very beginning, and it will take you years to catch up.

The smarter thing to do would be to keep the car you have until you have made enough loan payments to reduce the balance to less than the car value. That way you’ll have positive equity in your vehicle should you decide to sell or trade it in. If you pay off your loan and decide to keep it for another five years, 10 years or as long as it keeps running, you won’t have to worry about budgeting hundreds of dollars toward a monthly loan payment, and can save that money for a rainy day instead.