Everything is not what it seems
Sorry for the delay... but here are some recent thoughts on a topic I never stop thinking about...the car market
The summer is so busy, which is both a blessing and a curse. The fall shows no signs of slowing down, yet I will try to get out as many of these newsletters as possible. I wanted to take this week to address an idea floating around my mind right now.
As someone who goes back and forth about buying or leasing a vehicle, the financial aspect of acquiring a vehicle is something that constantly plays out in my mind. You see, I have a car approaching twenty years old that I still drive. It runs fine, and largely gives me no issues. That being said, it is 20 years old with a number of defects including dents, scratches, and rust. As someone with increasing responsibility in my community, it does seem time to upgrade my vehicle to something more visually appealing. As a side note, I’ve been upset by the way we let material items seep into our judgements about others in this country. The idea that many (and perhaps the majority of) Americans view someone’s wealth and societal prowess in part by the car they drive is very shallow… and yet this is the society we live in. The real worth of a person (if judged at all) should be by their actions and impact. I digress.
The point of this conversation is to talk about the best financial decision to make when acquiring a new car—both in terms of acquiring a car that meets your (in this case my) minimum societal standing, and also makes financial sense. In this economy rates are high. I am someone in the highest bracket of credit scores and even my car loan rate was around 8 percent from a regional bank. Doing more shopping, I probably could’ve reach the mid to low sevens, yet comparing current rates to a couple years ago (where a 3-5 percent loan was not uncommon) today’s rates are high. The part that bites the most financially about car loans is not only the rate, but also the length. This also applies to leases in terms of the monthly cost. Paying $300-1000 anywhere from 24-84 months is a lot of money and it adds up.
Rates are likely to remain high through the next couple years according to the Federal Reserve dot plot, meaning it’s unlikely we’ll see relief from high monthly payments any time soon. However, the length of your loan or lease is very important if you believe the economy will descend into recession soon. That’s because a recession will likely bring about one and possibly two big changes. If a recession hits and demand in the car market drops, it is very likely that car prices will drop at the dealer level. Basically, dealers will reduce the cost of vehicles so that they sell. Dealers cannot afford to sit on cars too long, and must sell cars to generate cash flow—more on this later. Lower costs at the dealer level means a smaller amount to finance, which translates to lower monthly payments.
The second element that a recession could precipitate is lower interest rates. The Fed often lowers the Federal Funds rate during a recession to increase demand for goods and services in order to spur the economy back to life after the drop off of a recession. A lower Fed Funds rate translates to lower interest rates on car loans—therefore reducing the total cost of the loan.
Wondering how a recession in early to mid 2024 affects your car buying decision today? You might think my answer is just wait until the recession if you believe it’s happening. Usually, my answer would be yes, but that doesn’t apply here because in this situation you need a car now. Let me explain, if you believe car prices and possibly rates on loans will be lower in a year, but you need a car now, the solution is a one-year lease. Sounds a little counter productive, right? One-year leases come with higher monthly payments than 24-36 month lease, and you don’t own the car at the end. Well that’s exactly the point. Leases allow you to walk away at the end of the lease (provided you don’t go over mileage), and you don’t have to worry about the value of the car. If you buy a car, you are likely exposing yourself to not only an extended period of monthly payments, but also a consideration about the resale value of the car. If you take a 24-36 month lease, you are locking yourself into paying a specific amount for that timeline. The beauty about a one-year lease in this example is that if a recession comes, you are able to return your car at the mid-year point of next year (usually dealers allow you to turn your car in a couple months before the end of the year and I’m assuming you are acquiring a new car in September or October) and then either lease a new car or buy a new one at a more favorable rate. Yes, you pay more upfront, but you are given more flexibility.
If you take a one-year lease and the recession hits causing prices and rates to drop, you can take advantage of this dip a year later. As a result, maybe that same model car you have now is cheaper and you are able to lock in a two or three-year lease or buy a new version of that model at a cheaper price. Even if the recession doesn’t hit and prices and rates are still high, you are able to adjust your spending or the type of car you select at the time to fit the new reality of your budget.
Borrowing money is a tricky thing. Longer time horizons means lower monthly payments, but you have to remember that lenders would not readily offer these options—for financing (72-84 month) and leasing (24-48 months)—if there wasn’t an incentive for them to do so. And the incentive is that the lenders can rely on steady cash flow for a longer time, which in business is the most important thing. Another sidenote, if you ever want to evaluate a company just look at their free cash flow; if a company has a lot of free cash flow relative to their debt payments then that company is likely to survive. If free cash flow is not enough to meet near-term debt payments, investing in that company may not be a great idea.
Disclaimer: This is not professional and/or financial advice. This content is for informational purposes only. Before making any financial decisions you should do your own research, evaluate your financial situation, and/or consult a financial professional.