Car Buying: Before Getting a Lease or Loan

Your three major alternatives when acquiring a vehicle are leasing it, financing it with a loan, or using your own cash to pay for it. Of course, when you pay for a car with your own cash, you're not beholden to any person or institution. However, if you lease or borrow, keep the following

Depreciation is a major factor

When deciding whether to finance a new vehicle with a lease or loan, keep in mind that the cost of a lease or loan is partially determined by the vehicle's rate of depreciation (or how much value the vehicle loses as it grows older) during the duration of the contract. For this reason, make sure that you know how much the vehicle you want will depreciate over the first two or three years you own it.

A new vehicle usually depreciates from 30 to 50 percent in the first three years in the United States, and an average of 2 percent per month in Canada. For this reason, you may decide to let someone else absorb the depreciation by selecting a 2- or 3-year-old, previously owned vehicle rather than a new one.

Also, the higher the purchase price, the more you'll continue to pay for licensing, registration, insurance, taxes, and interest. Be sure you understand how depreciation affects these arrangements and how you may end up paying for depreciation twice.

Credit or leasing companies require insurance

When you lease a car or purchase one with a loan, the lessor or the creditor can stipulate the kind of insurance you must get for your car. However, according to the AAA (American Automobile Association), although a credit or leasing company can require you to insure the vehicle for fire, theft, collision, and so on, it cannot force you to purchase a policy through a specific broker, agent, or company.

Look for the best coverage you can find before agreeing to purchase insurance through a dealer or financer, the person responsible for financing a lease or loan. If you decide to insure through one of these sources, do not let them include the insurance premiums in the cost of the lease or loan. If you do, you have to pay interest on your coverage.

You may need more than one type of insurance if you choose to finance a vehicle. You may consider getting some of the following types of insurance, for example:

• Auto insurance coverage: Financer-required insurance usually does not include any minimum liability insurance that your state or province requires, or anything else besides comprehensive and collision coverage to repair or replace the vehicle if it is damaged or stolen. Verify that all insurance policies are in effect before you take possession of the vehicle.

• GAP insurance: This type of insurance covers the difference between a vehicle's stated value in a finance contract and what an insurance company will pay if the vehicle is damaged beyond repair or stolen before the end of the finance period or lease. Some financing contracts provide GAP insurance free of charge; others include it as part of the up-front cost (the total amount you have to pay before you can drive a vehicle off the lot), and still others require you to purchase the insurance yourself. Although GAP insurance shouldn't cost more than a couple of hundred dollars, some policies can be much more expensive — especially if they're obtained through the financer.

Because a vehicle begins to depreciate as soon as you take possession of it, its replacement value soon may be substantially less than when you bought it, and your insurance policy may not cover the full amount that you'll have to come up with to compensate the financer, if the need arises.

• Credit life or credit disability insurance: These policies make your payments if you die or become disabled while your financing is still in effect. This coverage is usually optional and extremely overpriced. If you feel that your estate could not cover the payments in the event of your death, you can buy this type of insurance at a better price from an outside source.

Some credit unions supply this insurance at no charge because the rules in many unions specify that loan obligations be canceled in the event of death. Because unscrupulous financers sometimes slip this coverage in whether you want it or not, be smart and recalculate the monthly payment shown on the final contract to be sure they do not include this coverage as a hidden charge.

Manufacturer's rebates and financing offers

Car manufacturers with their own financing departments may offer lower interest rates on loans and leases than rates that are available from outside credit sources. To ensure goodwill, some pay the security deposit and first monthly payment when you lease the next car from them after a previous lease contract with them expires. Others offer perks such as free maintenance, auto club and towing services, emergency hotlines, stolen-vehicle tracking, and other goodies. Generally speaking, the more expensive the vehicle, the greater the perks offered by the manufacturer.

Auto manufacturers run frequent promotions that offer you the choice between a rebate or a low-interest deal. Ask your accountant or a friend who's good with numbers to work out which alternative would be the most profitable arrangement for you.

If you go for the rebate, ask the dealer to base the sales or lease contract on the price of the vehicle after the rebate has been deducted, instead of writing the contract for the original price and mailing you the rebate later on. Doing this enables you to avoid paying higher taxes,interest, registration fees, and perhaps insurance, on the pre-rebate price of the vehicle, which may be a couple of thousand dollars more than the vehicle actually costs you.