Wheel Deals

June 4, 2003

Next to a house, a vehicle is the most important expenditure most people make. Few, however, have a systematic approach to purchasing or leasing a vehicle. Here are some points to consider before you make this financial investment.
First, decide how much you can afford and resolve not to pay more. Most experts recommend that payments of any kind (except a mortgage) should not exceed 18 percent of one's take-home pay. 
Second, negotiate the best price possible by researching the dealer's invoice cost. This information is available from a number of sources such as AAA Auto Pricing Services, Auto Vantage, Consumer Reports' Auto Price Service and Nationwide Auto Brokers. These reports show the base price plus the cost of each option for a specified make and model. 
Before making an offer, add the cost of the car with the options you want, then offer 1 percent to 2 percent above that amount. Be aware that the invoice price usually is not actual cost; most dealers get holdbacks or rebates from manufacturers. Be prepared to negotiate a markup of up to 3 percent or 4 percent, but make it clear you are shopping around and check with several dealers. Do not get into a lengthy negotiation or discuss trade-in or financing until the price is established.
When a firm price is negotiated, you can determine what you will receive for a trade-in. In most cases, you can sell your car yourself for more than this amount, but don't forget to calculate the sales tax differential. For example, if you are offered $10,000 for the trade-in, you pay sales tax on $10,000 less on the new vehicle. At 6.25 percent, that is a $625 difference, so you would need to sell your car for more than $10,625 to come out ahead.
Now that you know the net price, calculate the total cost of leasing vs. purchasing. One Web site available to aid in this calculation is http://autos.yahoo.com/finance/calcloanlease.html. You will need to obtain the following information:
For a loan: purchase price, down payment, sales tax, monthly loan payment, estimated value of car at end of loan and opportunity cost (i.e., the rate you could earn on your savings).
For a lease: the capitalized cost of the car, the estimated residual value, the finance rate, the lease term, capital cost reduction (i.e., down payment), security deposit, monthly lease payment, opportunity cost and disposition fee or other charges (most leases require a $150 to $250 disposition fee when the car is returned).
You will have a choice between an open-end or closed-end lease. On a closed-end lease, the only additional charge would be for "excessive wear and tear" or excess mileage. A good contract should define clearly what is considered excessive wear or mileage. Most experts do not recommend the open-end lease because total cost will depend on the appraised value of the car upon its return. It is recommended that you negotiate a fixed-purchase option at the end of the lease, which gives you the option to return the car or buy it at a predetermined price.
In most cases, consumers who own a business and can deduct the entire lease payment are most likely to benefit from leasing. Lease contracts can be complicated, so read the entire contract carefully before making a decision.

Dr. Potts, BBA '66, MS '68, PhD '78 (Louisiana State University), is associate professor of finance in the Hankamer School of Business.