An early termination charge may be levied if you decide to end a lease prematurely.

8 Vehicle and Other Major Purchases

YOU MUST BE KIDDING, RIGHT?

When Dora Marquez graduated from college three years ago, she really wanted a fully equipped Honda Civic. Her monthly payment would be about $350 per month, about $70 more than she could afford. To help Dora meet her budget, the dealer suggested that she lease the vehicle and offered a 42-month lease option at $270 per month with a driving maximum of 12,000 miles per year. The contract had a $0.30 per mile fee at the end of the lease for any excess mileage. Now, with six more months on her lease, Dora is already 1500 miles over the 42,000 (3.5 × 12,000) mileage limit in her contract. What is Dora's best option at this point?

A. Turn back the vehicle now and pay the $450 (1500 × $0.30) for excess mileage.

B. Try to cut back on her driving to minimize her excess mileage fee, which could be higher than $2500 if she keeps driving at the same rate as she has been.

C. Stop driving the car and pay $450 for excess mileage when she turns it back at the end of the lease.

D. Continue driving the vehicle and buy it at the end of the lease by paying the residual value agreed upon when she entered into the contract.

The answer is D. None of the other options is financially practical. Dora learned a hard lesson. Leases may have a lower monthly payment but have hidden costs that often are not known until the very end of the contract!

LEARNING OBJECTIVES

After reading this chapter, you should be able to:

 Explain the first three steps in the planned buying process that occur prior to interacting with sellers.

 Describe the process of comparison shopping.

 Negotiate and decide effectively when making major purchases.

 Use effective complaint procedures.

WHAT DO YOU RECOMMEND?

David and Lisa Cosgrove of Tacoma, Washington, are in their early 40s and have three children. They own three vehicles. Lisa drives an almost-new Toyota Camry; David uses a five-year-old Ford pickup; and Alyssa, the couple's 17-year-old daughter, drives a ten-year-old Dodge. Recently, a fire in their garage destroyed both the Dodge and the Camry. The Cosgroves received an insurance settlement of $21,900 on Lisa's car, although the loan payoff amount was $22,800. Alyssa's Dodge was not insured for fire. The couple wants to obtain replacement cars that are similar to those destroyed.

What do you recommend to David and Lisa on automobiles and other major purchases regarding:

1. How to search for two vehicles to replace those destroyed?

2. Whether to replace Lisa's vehicle with a new or used vehicle?

3. Whether to lease or buy a vehicle?

4. How to decide between a rebate and a special low APR financing opportunity if they decide to purchase a new vehicle for Lisa?

5. How to negotiate with the sellers of the vehicles?

YOUR NEXT FIVE YEARS

In the next five years, you can start achieving financial success by doing the following related to vehicle and other major purchases:

1. Check repair ratings history in the April issue of Consumer Reports magazine when planning to buy vehicles.

2. Purchase late-model, high-quality used vehicles and obtain a vehicle history report at www.carfax.com and www.autocheck.com and any recall history at www.nhtsa.gov .

3. Obtain price information from at least three sources and aggressively negotiate prices and financing terms for major purchases.

4. Never tell a seller what payment you can afford.

5. Promptly and firmly seek redress when dissatisfied with purchases or services.

Planned buying entails thinking about the details of a purchase from the initial desire to buy to your satisfaction after the purchase. You should use planned buying principles any time, but they are especially important when you are buying a vehicle or making other major purchases. You can save thousands of dollars when buying a car and hundreds of dollars when purchasing a television. You just need to learn how to do it. If you do not plan your buying in such circumstances, you will waste money, and this will detract from your overall financial success in life.

The seven distinct steps that lead you through the planned buying process are illustrated in Figure 8-1. Steps 1, 2, and 3 occur before you interact with sellers: determining your needs and wants, performing preshopping research, and fitting a purchase into your budget. Comparison shopping and other interactions with sellers comprise the 4th step in the buying process. Steps 5 and 6—negotiating and making the decision—follow. The 7th and final step—evaluation of the decision—is taken after making the purchase. After reading this chapter, you will understand enough about the planned buying process to save money when buying expensive goods while still meeting your needs and many of your wants.

8.1 DO YOUR HOMEWORK BEFORE YOU BUY

Let's look now at the first three steps in planned buying, all of which should occur before you actually interact with sellers. They are, in a sense, the homework you do when preparing to buy.

LEARNING OBJECTIVE 1

Explain the first three steps in the planned buying process that occur prior to interacting with sellers.

8.1a Wants Versus Needs

A need is something thought to be a necessity; a want is unnecessary but desired. In truth, very few needs exist. Yet in everyday language, people talk too often of “ needing” certain things. Calling something a need makes it no longer open to careful consideration. Instead, consider all purchase options to be wants. Of course, some wants are more important than others. That is why you must prioritize your wants and consider the benefits and costs of each want. Costs should include opportunity costs as measured by some other want or goal that will become less attainable if a given want is satisfied. For example, buying a car with a retractable sunroof might mean that you cannot afford to purchase one with a remote start feature.

need Item thought to be necessary.

want Item not necessary but desired.

Figure 8-1 The Steps in Planned Buying

Setting priorities becomes difficult when a decision is complex such as when buying a car or home. Consider the case of Haley Wilson, a physical therapist from St. Paul, Minnesota. Haley has been late to work several times in the past few months because her 12-year-old car has been having too many mechanical problems. Haley wants to avoid being late. But how? Should she buy a new car or a used car, lease a new car, repair her current car, or take the bus to work? After considering these options, Haley decided to buy a new car. Now she must determine which features are of high or low priority. To do so, Haley developed the worksheet shown in Figure 8-2. Such a worksheet makes it easier to formalize her wants.

FINANCIAL POWER POINT

Avoid Impulse Buying

Buying too quickly without fully considering priorities and alternatives is called impulse buying . It wastes money, and impulse buyers often do not buy what they really want and later on they too often regret their decisions.

impulse buying Buying too quickly without fully considering priorities and alternatives.

8.1b Get Smart and Conduct Some Preshopping Research

Smart shoppers learn as much as they can about a product or service before buying. This process starts with preshopping research —gathering information before actually beginning to interact with sellers. Manufacturers, sellers, and service providers are all important sources of information about products and services during preshopping research. Two other sources are friends and consumer information in print and on the Internet.

preshopping research Gathering information before actually beginning to interact with sellers.

Figure 8-2 Priority Worksheet (for Haley Wilson)

DID YOU KNOW

Bias Toward the Familiar and Comfortable

People engaged in understanding vehicle and major purchases have a bias toward certain behaviors that can be harmful, such as a tendency toward the familiar and comfortable. People often keep buying the same items and name brands when making major purchases. What to do? Treat every major purchase as a new opportunity; then carefully go through the planned buying steps to make the best choice.

When buying vehicles you should always research vehicle reviews in Consumer Reports, which is the only magazine that objectively tests and reports on numerous product categories. Monthly issues of Consumer Reports generally provide a two- to five-page narrative analyzing the products and summarizing the information in chart form. Consumer Reports Buying Guide, which is published every December, lists facts and figures for all kinds of products. And each year, the April issue of Consumer Reports is devoted entirely to the purchase of automobiles. All this and more can be seen at www.ConsumerReports.org.

Know the Price You Should Expect to Pay Advertising is often a key source of information about prices. You can also obtain price information through catalogs, on the telephone, and over the Internet. This situation differs for big-ticket items. While the prices of furniture, appliances, and vehicles may be advertised, that price is almost never the lowest price you can expect to pay. This is because sellers of big-ticket items typically have the authority to negotiate an even lower price, if necessary, to make a sale. You should have a clear understanding what price to expect to pay before going out to shop. Otherwise, you risk negotiating a price higher than necessary.

Break the Dealer's Code on New Vehicle Prices You will see two prices when you walk into a vehicle dealer's showroom: (1) manufacturer's suggested retail price, and (2) dealer invoice price. Both are artificial numbers; thus your negotiation effort should not be to get close to the dealer invoice price but to a lower real price you may decide to pay. The manufacturer's suggested retail price (MSRP) is the retail price set by the manufacturer and posted on the federally required side window sticker. The dealership wants you to pay full MSRP plus any miscellaneous charges.

manufacturer's suggested retail price (MSRP) The retail price set by the manufacturer and posted on the federally required side window sticker.

The dealer invoice price (or base invoice price ) is the amount the automaker charges the dealership for new vehicles at the time the dealer buys them, and it does not reflect some discounts that the dealer gets. The invoice price typically has some additional charges tacked on by the dealer, which are attempts to generate additional revenue.

dealer invoice price (base invoice price) The amount the automaker charges the dealership for new vehicles at the time the dealer buys them; it does not reflect some discounts that the dealer gets.

FINANCIAL POWER POINT

Research Online Product Reviews

Taking time to read online reviews of products and services may yield useful information in making buying decisions. Take time to read both anonymous praise and critical comments on sellers' websites as well as blogs. Some positive postings might be written by company minions, while some negative ones may be the work of unscrupulous competitors. It is best to ignore occasional extreme reviews and focus on the general tone.

Web Sources Are Best for Price Information on Vehicles Edmunds.com reports that the average price for new cars and trucks is over $32,000. Smart buyers can research the average retail and wholesale prices on new and used vehicles by visiting the websites for Edmunds (www .edmunds.com), Kelley Blue Book (www.kbb.com), or the National Automobile Dealers Association (www.nadaguides.com).

Know the Value of Your Trade-in Vehicle When buying vehicles, it is common but not always advantageous, to trade in an old model when buying a new one. Vehicle buyers should know the true value of any vehicle they will trade in. Using the websites mentioned earlier, you may find the likely trade-in value of your vehicle (the wholesale price) as well as the amount you could sell it for yourself (the retail price). Armed with this information, you can more effectively negotiate a good trade-in allowance on your existing vehicle with a dealer. If you don't get a good offer on your vehicle from the dealer, shop at another dealer or consider selling it yourself.

Gauge Environmental Impact Many products such as vehicles, electronic equipment and household appliances have an impact on the environment. This factor is part of many people's purchase decisions and relevant information is often available. For example, window stickers on new vehicles include both estimated annual fuel costs and the vehicle's overall environmental impact. The labels also compare vehicles across classes so potential buyers can make more informed decisions.

8.1c Know What You Can Afford

When considering a big-ticket item everyone wonders, “Can I afford it?” An unaffordable cash purchase can wreck your budget for one or two months. However, the negative effects of an ill-advised credit or lease contract may last for years.

DID YOU KNOW

Many People Are Slow to Replace Their Cars

Surveys show that about 15 percent of vehicle owners replace their cars before they have 100,000 miles, more than half get another vehicle when the old one has between 100,000 and 250,000 miles on the odometer, and about one-quarter wait for 250,000 or more miles.

Consider the Cost per Use One way to view the cost of a major expenditure is to consider the cost per use of the product. For example, Dylan Lenz, an engineer from Dothan, Alabama, is considering buying a hot tub spa. He has researched several models and knows he would pay about $5000 for a model he likes including installation. Dylan figures that he would use the spa about 100 times per year and expects the spa to last about ten years, giving him 1000 uses. Dividing this figure into the price of a $5000 model yields a cost per use of $5($5000/1000), excluding the cost of chemicals, maintenance, and electricity to heat the unit. Dylan must consider if it is worth more than $5 each time he uses the spa and whether he will really use it about twice per week year in and year out.

Fit the Payment into Your Monthly Budget Many big-ticket items require the use of credit resulting in an impact on one's budget for many months in the future. To gauge this impact, consider how Haley Wilson (see Table 8-1) might fit a new car into her budget. She estimates that the dealer invoice price of the car she wants will be about $28,000. This price does not include her highest-priority wants. These options will likely add about $3300 more to the dealer invoice price: air conditioning, $700; automatic transmission, $600; leather seats, $700; capless fuel filler, $100; power windows, $400; top-level sound system, $600; and satellite ratio, $200. Buying a car with these features will run the cost up to $31,300 ($28,000 + $3300 for the options). She expects to use $3500 from her savings account as a down payment, receive $2000 for trading in her old car, and borrow the remaining amount.

DO IT IN CLASS

The actual price she will pay for the car will depend on her ability to negotiate the final price down from the dealer invoice price. From her preshopping research, Haley knows that the final agreed upon price should be about 12 percent less than the dealer invoice price. Haley figures she should be able to negotiate the price of the purchase down by at least 10 percent from $31,300 to $28,170 ($31,300 − $3130 [$31,300 × 0.10]).

The final cost Haley will pay depends on (1) the price she actually pays for the car, (2) the amount of the down payment, (3) the time period for payback of the loan, (4) the amount she receives in trade for her old car, and (5) the interest rate on the vehicle loan. Assuming a car price of $28,170 and another $830 for sales tax and title fees to register the vehicle, Haley will need to finance about $29,000 ($28,170 + $830). The monthly payment over 48 months for a 5 percent loan could be about $668 a month (from Table 7-1 on page 213 [$23.03 × 29]).

Time invested in preshopping research pays off in better purchase decisions.

Fit the Vehicle Payment into a Monthly Budget The next challenge is to determine if a possible vehicle payment is truly affordable. Haley tried to fit the $668 car payment into her budget as shown in Table 8-1.

Table 8-1 shows Haley's monthly budget. She started with the fact that her take-home pay of $2440 is totally committed, including $200 in monthly savings. So she juggled the numbers to see if she could finance a new car and found she could only find $330. That's far short of the $668 needed for a monthly payment. By taking out a longer, 60-month 5 percent loan, she could reduce her payments to about $547 per month (29 × $18.87 from Table 7-1 on page 213). Haley's choices are to make more cutbacks in her budget, work overtime, get a part-time job, or buy a less expensive vehicle.

Table 8-1 Fitting a Vehicle Payment into a Monthly Budget (Haley Wilson's $2440 Disposable Income)

FINANCIAL POWER POINT

How Many Hours of Work Will This Item Cost?

When buying a new vehicle, computer, television, or any big-ticket item, divide the cost of the item by your hourly take-home pay. For example, if you divide the cost of a $360 camcorder by $15 take-home pay ($22 hourly minus taxes), that tells you that you must work 24 hours to pay for it.

Alternatively, Haley could finance the car over more months. Thirty-three percent of new cars are financed for 73 to 84 months and over 20 percent are financed over 61 to 72 months. While this lowers the monthly payment, it extends the loan for a long time (perhaps longer than you want to drive the vehicle) and it costs a lot more in total interest. Perhaps she might qualify for a lower interest rate, maybe 3½ percent, at the new car dealer. Then again, Haley could forget the new car entirely and look for a used vehicle that is affordable.

 CONCEPT CHECK 8.1

1. What is planned buying?

2. Distinguish between needs and wants, and explain why it may be better to act as if no needs exist.

3. Describe the types of information you need to be your own expert when making big-ticket purchases.

4. Summarize the process to determine whether you can afford a particular purchase.

DID YOU KNOW

How to Buy a Safe Car

The following pointers may help you buy a safer vehicle:

• Check government safety test results. The federal government crash-tests motor vehicles to analyze their safety. For results on various makes and models, call the National Highway Traffic Safety Administration (NHTSA) “auto hotline” at (800) 424-9393 or visit www.safercar.gov.

• Consider a vehicle with extra airbags. Consider models that provide head, knee, rear-curtain, seat-belt, and/or rear-seat-center airbags.

• Check on recalls. When buying a used car, visit SaferCar.gov to see whether the vehicle has been recalled. If so, confirm that the repairs have been made to the car you are considering; if not, buy elsewhere. Dealers are required to fix for free vehicles recalled for safety reasons.

8.2 USE COMPARISON SHOPPING TO FIND THE BEST BUY

Comparison shopping is the process of comparing products or services to find the best buy. A best buy is a product or service that, in the buyer's opinion, represents acceptable quality at a fair or low price for that level of quality. Purchasing the product with the lowest price does not necessarily ensure a best buy because quality and features count, too.

comparison shopping Process of comparing products or services to find the best buy.

best buy Product or service that, in the buyer's opinion, represents acceptable quality at a fair or low price for that quality level.

Prices on big-ticket items such as autos, furniture, appliances, and electronic equipment are rarely the same from seller to seller and vary from week to week. You can begin your comparison shopping online, but most likely you will need to visit different stores to see the products. Experts recommend that consumers use the “rule of three” when shopping at stores. This means comparing at least three alternatives before making a decision.

8.2a Compare Financing Options

The lowest payment does not mean the best credit plan. Better credit terms are frequently available at lenders not associated with sellers such as your credit union or bank that can lend money to make purchases for vehicles and household appliances and other big-ticket items. Also check rates on websites such as www.bankrate.com or www.interest.com.

Avoid Long-term Borrowing Beware of taking out a longer loan on a vehicle purchase, such as for five or more years, because the value of your vehicle may be less than the amount you owe for half or more of those years. This is known as being upside down due to negative equity. If you default on the loan or sell the vehicle, you will have to make up the difference. Rolling the negative equity forward into the car financing of the next vehicle purchase means that the amount will be added to the price of the new car.

upside down A situation where the owner of a financed asset owes more than it is worth, thus creating negative equity.

When talking with sellers, consider “same as cash” offers on furniture, appliances, and electronics that allow you to delay interest or payment for, perhaps, 90 days to one year. If the product is paid off during this time period, you will not incur any finance charges. Be wary, however, because interest will be charged retroactively if a payment is late or if the purchase isn't fully paid off during the required time period.

When shopping for an automobile and going on a test-drive, tell the seller not to use your Social Security number or driver's license number to access your credit report and estimate how much you can afford to pay and your ability to obtain financing elsewhere.

LEARNING OBJECTIVE 2

Describe the process of comparison shopping.

What Is a Fair Interest Rate? A borrower with a high credit score who can get a 1 percentage point reduction in interest for a $15,000 loan over 48 months can save hundreds of dollars in interest paid over the life of the loan. You should note that the credit score used on vehicle loans will be different than the one you might obtain on your own. Credit bureaus have developed specialty scores for vehicle lending that have a heavier weighting placed on past experiences the borrower has had for those types of loans. Buyers should obtain multiple quotes from credit unions and banks. When shopping for a major purchase, ask your local credit union or bank for a loan preapproval before you visit sellers. This preshopping step will let you know how much you can borrow and at what interest rate.

Choose Between a Low Interest Rate and a Rebate Often a good source of loans for new vehicles is sales financing arranged through the dealer or manufacturer. The interest rate on this credit is usually low when manufacturers or dealers want to generate additional sales volume.

Many sellers also offer rebates to encourage people to buy. With a rebate, the seller refunds a portion of the purchase price of the product either as a direct payment or a credit against future purchases (often through a gift card). Vehicle manufacturers offer rebates of $1000 to $5000 to purchasers of new vehicles as a way to generate more sales volume or to help sell slow-selling models. In most cases, the buyer must choose between the rebate and a low APR loan offer also being offered by the manufacturer. Some people choose to borrow the full price elsewhere and receive the rebate in cash. In effect, this option means that they are borrowing more money than the vehicle actually costs. Plus, the buyers also lose out on the opportunity for the low APR offer.

DID YOU KNOW

Seven Things to Buy Used

Most everyone knows that used vehicles are a good option when the time comes to make a purchase. But a number of other products can be bought used as well with good quality for a low price. Sources such as eBay, Craig's List, Amazon, Goodwill Industries, the Salvation Army, consignment shops, and even garage sales can be a good source for used:

1. Fitness equipment—many people buy treadmills, elliptic trainers, stationary bikes and other such items and rarely use them. When the time comes to sell they are selling almost new items.

2. Furniture and appliances—Serviceable used furniture can be a good buy for young people just starting out or people who have moved into a larger dwelling and want to wait to furnish it fully.

3. Baby gear and clothing—Why buy new when the baby will outgrow the items in a few short months?

4. Jewelry—Buying wedding bands at a pawnshop may not be romantic but when money is tight nice items can be had at a fraction of the cost of new.

5. Electronics—many people want the very newest electronics and trade in or sell items that are technologically current.

6. Tools—many do-it-yourselfers buy tools for jobs they will not do again and will sell items that have used only a few times.

7. Sporting equipment—Golf clubs, skis, bicycles, and roller blades have winning prices at stores specializing in used equipment.

FINANCIAL POWER POINT

People Waste Rebates

Only about half of people who buy manufacturers' products that offer rebates actually take the time to complete and mail in the forms to obtain the money. The rate is even lower on items costing less than $50. Advice: Complete and mail such forms as soon as you return home with the purchase.

The Run the Numbers worksheet on page 231 provides a way to calculate whether a rebate or low APR financing is the better option. If you do decide to take the rebate on a new vehicle, you should apply the money to the down payment on the vehicle or pay extra on the first monthly payment on the loan. Rebates are common when purchasing products such as vehicles, cell phones, and computers. The most current details on manufacturers' rebates to both consumers and auto dealers can be found at Edmunds.com (www.Edmunds.com). Just type in “rebates” on the Internet for others.

8.2b Compare Leasing to Buying

Leasing a new vehicle is an increasingly attractive option to people who are in the market for a car. More than 28 percent of the new cars “sold” in a recent year were actually leased. A person leasing a vehicle does not actually own the vehicle. With a lease on a vehicle or any other product, you are, in effect, renting the product while the ownership title remains with the lease grantor.

lease Rental of a product while ownership title remains with the lease grantor.

Is leasing a better deal than financing? It could be. Note first that the monthly cost of leasing is always lower than a purchase. This is because the payment is primarily based on the depreciation of the vehicle over the lease time period and also because in most states the sales tax is calculated on the monthly lease payment rather than the full purchase price. Still, you cannot answer this question until you understand some rules and risks of leasing.

Regulation M issued by the Federal Reserve Board governs lease contracts. A requirement of this regulation is a mandatory disclosure of pertinent information about the lease that the consumer is considering. The disclosure form must summarize the offer of the lessor (leasing agency) to the lessee (consumer). The information in this form should be compared with the actual lease contract prior to signing to ensure that the lease signed is actually what was agreed upon verbally.

RUN THE NUMBERS

Choosing Between Low-Interest-Rate Dealer Financing and a Rebate

Advertisements for new vehicles often offer low APRs for dealer-arranged loans. A cash rebate of $1000 to $3000 (or more) off the price of the car may be offered as an alternative to the low interest rate. If you intend to pay cash, then the cash rebate obviously represents the better deal. But which alternative is better when you can arrange your own financing?

To compare the two APRs accurately, you must add the opportunity cost of the forgone rebate to the finance charge of the dealer financing. The worksheet provides an example of this process. Suppose a dealer offers 2.9 percent financing for three years with a $907 finance charge. Alternatively, you can receive a $3000 rebate if you arrange your own financing. The price of the car before the rebate is $22,000. Assume you can make a $2000 down payment and that you can get a 6.5 percent loan on your own. This worksheet can be found on the Garman/Forgue companion website, or you can find similar worksheet at www.bankrate.com/calculators/auto/car-rebates-calculator.aspx.

DO IT IN CLASS

The lower of the values obtained in steps 3 and 4 is the better deal. In this instance, the financing that you arranged on your own is more attractive. In fact, any loan you arrange that carries an APR lower than 12 percent compares favorably with the dealer-arranged financing in this case.

Step

Example

Your Figures

1. Determine the dollar amount of the rebate.

    $3000

_________

2. Add the rebate amount to the finance charge for the dealer financing (dollar cost of credit).

+ $ 907

_________

3. Use the formula from Chapter 7 (Equation [7.2] on page 215 and used here as Equation [8.1]) to calculate an adjusted APR for the dealer financing.

where

APR = Annual percentage rate

     Y = Number of payment periods in one year

     F = Finance charge in dollars

     D = Debt (amount borrowed)

     P = Total number of scheduled payments

4. Write in the APR that you arranged on your own.

6.5%

_________

Leasing Terminology Five terms are important in leasing:

1. The gross capitalized cost (gross cap cost) includes the price of the vehicle plus what the lessee paid to finance the purchase plus any other items the lessee agreed to pay for over the life of the lease, including insurance or a maintenance agreement.

gross capitalized cost (gross cap cost) Includes vehicle price plus the cost of any extra features such as insurance or maintenance agreements.

2. Capitalized cost reductions (cap cost reductions) are monies paid on the lease at its inception, including any down payment, trade-in value, or rebate.

3. The adjusted capitalized cost (adjusted cap cost) is determined by subtracting the capitalized cost reductions from the gross capitalized cost.

adjusted capitalized cost (adjusted cap cost) Subtracting the capitalized cost reductions from the gross capitalized cost.

4. The residual value is the projected value of a leased asset at the end of the lease time period.

residual value Projected value of a leased asset at the end of the lease time period.

5. The money factor (or lease rate or lease factor) measures the rent charge portion of your payment. Although the money factor is sometimes described by dealers as a figure for comparing leases, lease forms must carry the following disclosure about the money factor: “This percentage may not measure the overall cost of financing this lease.”

What is most important when considering leasing? Always negotiate the purchase price before discussing a lease! Leasing requires an initial outlay of cash to pay for the first month's lease payment and a security deposit. Payments are based on the capitalized cost of the asset minus any capitalized cost reductions and the residual value. This difference represents the cost of using the asset during the lease period; when divided by the number of months in the contract, it serves to establish the base for the monthly lease payment. (Some new vehicles are offered with single-payment leases in which the entire difference between the capitalized cost and residual value is paid up front.) With monthly payment leases, the payments are lower than monthly loan payments for equivalent time periods because you are paying for only the reduction in the asset's value—not its entire cost. To compare the costs of leasing versus buying, use the Run the Numbers worksheet, “Comparing Automobile Financing and Leasing.” Also see www.leasecompare.com.

Open- and Closed-End Leases A lease may be either open end or closed end. In an open-end lease, you must pay any difference between the projected residual value of the vehicle and its actual market value at the end of the lease period. When a vehicle depreciates more rapidly than expected, the holder of an open-end lease has to pay extra money when the lease expires. For example, a vehicle with an $11,000 residual value but a $10,250 market value would require an end-of-lease payment of $750 ($11,000 − $10,250). The Consumer Leasing Act limits this end-of-lease payment to a maximum of three times the average monthly payment.

Most vehicle leases are closed-end leases. In a closed-end lease (also called a walkaway lease ), the holder pays no charge if the end-of-lease market value of the vehicle is lower than the originally projected residual value. However, closed-end leases may carry some type of end-of-lease charge if the vehicle has greater than normal wear or excess mileage. For example, a four-year closed-end lease might require a $0.30 per mile excess mileage charge in excess of 55,000 miles. If you actually drove the vehicle 60,000 miles during the four years, you would be charged an extra $1500 [$0.30 × 5000 (60,000 − 55,000)].

closed-end lease/walkaway lease Agreement in which the lessee pays no charge if the end-of-lease market value of the vehicle is lower than the originally projected residual value.

excess mileage charge Fees assessed at the end of a lease if the vehicle was driven more miles than originally specified in the lease contract.

RUN THE NUMBERS

Comparing Vehicle Financing and Leasing

This worksheet can be used to compare leasing and borrowing to buy a vehicle. Remember that the cost of credit is the finance charge—the extra that you pay because you borrowed. Leases also carry costs, but they are hidden within the contract. Indeed, some may remain unknown until the end of the lease period. These lease costs, which are indicated by an asterisk (*), are negotiable and are defined in the text. Ask the dealer for the price of each item, as these fees must be disclosed by dealers. Then complete the worksheet and compare the dollar cost of leasing with the finance charge on a loan for the same time period.

To make the comparison accurately, you must know the underlying price of the car as if you were purchasing it. Often you are not offered this value with a lease arrangement, so you should always negotiate a price for the vehicle before mentioning your interest in leasing.

DO IT IN CLASS

Also, shop for a lease through dealers and independent leasing companies because costs vary widely. This worksheet can be found on the Garman/Forgue companion website, or you can find a similar worksheet at www.bankrate.com/calculators/auto/buy-or-lease-calculator.aspx.

Step

Example

Your Figures

1. Monthly lease payment (36 payments of $375, for example)

$13,500

________

2. Plus acquisition fee* (if any)

      300

________

    Plus disposition charge* (if any)

      300

________

    Plus estimate of excess mileage charges* (if any)

         0

________

    Plus projected residual value of the vehicle

   4,500

________

3. Amount for which you are responsible under the lease

 18,600

________

4. Less the adjusted capitalized cost (gross capitalized cost* less the capitalized cost reductions*)

 16,000

________

5. Dollar cost of leasing to be compared with a finance charge if you purchased the vehicle

   2,600

________

With either an open- or closed-end lease, you may purchase the vehicle at the end of the lease period. With an open-end lease, you would pay the actual cash value. With a closed-end lease, you would pay the residual value.

Understand Common Leasing Fees Other charges are possible with a lease. An acquisition fee is either paid in cash or included in the gross capitalization cost. It pays for a credit report, application fee, and other paperwork. A disposition fee is assessed when you turn in the vehicle at the end of the lease and the lessor must prepare it for resale. An early termination charge may also be levied if you decide to end the lease prematurely. Be wary of a lease with an early termination charge, even if you do not plan to end the lease early, because termination also occurs when a leased vehicle is traded in or is totally wrecked or stolen. Make sure you obtain a written disclosure of these charges well before you actually make your decision. The early termination payoff is the total amount you would need to repay if you end the lease agreement early; it includes both the early termination charge and the unpaid lease balance. In its early years, your lease may be financially upside down, which means that you owe more on the vehicle than it is worth.

FINANCIAL POWER POINT

Do Not Lease Just to Drive a Better Vehicle

Leases work best for people who wish to drive a new vehicle every two or three years and, thus, have decided that they will always have a car payment. If you do choose a leasing option, your goal should be to lower your monthly cost rather than to “buy more car.” Otherwise, in just a few years, you will find that you have spent big bucks for a vehicle you must turn back in or have to pay extra to buy as a used vehicle.

Be Cautious About Leasing Getting a good deal on a leased vehicle can be very complicated. Therefore, be cautious if you talk about buying the vehicle all through the negotiation process only to be offered a lease at the last minute. The seller might realize that the purchase price is too high for you and can get you into the same vehicle for a lower monthly payment. But you may be tempted to sign a deal that actually costs considerably more. In addition, make sure all oral agreements related to trade-in value, mileage charges, and rebates are included in the lease contract.

Avoid Balloon Loans One option for people considering leasing versus buying is a balloon automobile loan. You can arrange this type of financing through your bank or credit union. With a balloon automobile loan , you actually buy the vehicle with the last monthly payment equaling the projected residual value of the vehicle at the end of the loan period. This arrangement effectively lowers all the other earlier monthly payments to make them more competitive with lease payments. When the final balloon payment is due, perhaps one to several thousand dollars, the borrower generally has three options:

balloon automobile loan A loan that has a low monthly payment similar in amount to that required if the vehicle had been leased and with a large final payment similar in amount to the residual value under a lease.

1. Sell the car and pay the balloon payment with the proceeds (with luck, the vehicle will sell for a high enough amount).

2. Pay the balloon payment and keep the vehicle.

3. Return the vehicle to the lender to cover the balloon payment.

FINANCIAL POWER POINT

It Is Possible to Get out of a Lease Early

People eager to get out of a lease might consider a lease-swapping website such as leasetrader.com and swapalease.com. These companies try to match people who want to get out of a lease early with those who want to assume a short-term lease. They charge fees to post your vehicle's information, and your original leasing company likely charges a transfer fee.

Be Cautious About “Gap” Insurance New cars and low-mileage used cars depreciate (go down in value) very quickly after purchase, often as much as 25 percent after leaving the dealer's lot. If you take out a vehicle loan with a low down payment, it is possible that the value of the vehicle will go down faster than the amount owed. As a result, you can owe more on the vehicle than it is worth. This situation is referred to as being upside down and can easily last for up to two years following the initial purchase.

Being upside down can be a big problem when a newer vehicle is totaled in an accident. In such cases, the insurance company will reimburse for the value of the vehicle, not the amount owed on the loan. Car dealers sell gap insurance that pays off the remainder of the loan if the insurance payment is insufficient to do so. While gap insurance is attractive, it is very profitable for the dealer and not such a good deal for the buyer. You should consider the possibility of being upside down as a sign that you are not making a large enough down payment or that you are buying a vehicle that is too expensive for you.

8.2c Compare Warranties

Warranties are an important consideration in comparison shopping. Almost all products have warranties —assurances by sellers that goods are as promised and that certain steps will be taken to rectify problems—even if only in the form of implied warranties. The longer the warranty is and the more it covers, the better the warranty.

warranty Sellers' assurances that goods are as promised and that certain steps will be taken to rectify problems if they arise.

Implied and Express Warranties Under an implied warranty, the product sold is warranted to be suitable for sale (a warranty of merchantability) and to work effectively (a warranty of fitness) whether or not a written warranty exists. Implied warranties are required by state law. The only way to avoid them is if the seller states in writing that the product is sold as is . If you buy any product as is, you have no legal recourse if it fails to perform, even if the salesperson made verbal promises to take care of any problems. Used cars are often sold as is.

as is Way for the seller to get around legal requirements for warranties; the buyer takes all risk of nonperformance or other problems despite any salesperson's verbal assurances.

Written and oral warranties are called express warranties. Companies that offer written