New vs used car

Question: I'm trying to figure out a few things regarding buying a car. We always buy used, does it ever make sense economically to buy a new car? I've always heard they loose a great deal of value when you drive them off the lot. Also, with interest rates so low right now, would it be better to finance for three years and let inflation take a small bite out of the total you pay (even though the interest bites back), or should we wait until 2011 when we can just pay cash since our savings for buying a car is earning so little interest? Is financing ever better than saving and then paying cash? Josh, Minneapolis, MN

Answer: You're right, the economics of a new car are peculiar.

You buy a car at a decent price after researching new cars, getting good information from various consumer-oriented websites like ConsumerReports.org and Edmunds.com, negotiate hard with the dealer, and then the car's value plunges by 20 percent to 30 percent when you drive off the lot.

However, the sudden depreciation in value doesn't rule out buying new. It only matters if you plan on selling the car within a few years. It's a meaningless event so long as you drive the car into the ground. With a new car you should get three or more trouble-free years of driving under a comprehensive warranty. Another benefit to buying a new car is taking advantage of the most fuel efficient options on the road, as well as advances in safety.

Still, for many people the cost savings from buying used are simply too great to pass up. Yes, a used car is to some extent is damaged goods by definition. You'll inherit someone else's problems. But if you've done your homework well, a used car will save you a lot of money. I've essentially evaded the issue by buying new and driving the car until it's essentially worthless. The car looks pretty beat up, but I don't really care.

It's always cheapest to buy a car with cash. Period. But sometimes it makes sense to borrow to buy even when you have the savings. For instance, maybe you're worried about getting laid off, there are some medical bills in your future, or you'd like to have a nice pot of money available in case an opportunity comes along. In that case a loan can be a smart move. By borrowing--using Other People's Money--you get the car you need and you keep your financial flexibility.

Interest rates are low and plenty of lenders will be eager to do business with you. Shop around the best loan deal available. Check out your credit union, local banks, and the automakers' financing companies. Don't take out a loan longer than three years. Make sure there is no prepayment penalty with the loan. You can always pay the loan off in full early.

About the author

Chris Farrell is the economics editor of Marketplace Money.

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