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Questions to ask yourself when financing a car

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The best way to pay for your new wheels depends on what matters most to you

Apart from a house, a new car is likely one of the largest purchases you'll make, so trying to sort out your financing options can understandably feel overwhelming. It can help if you break the decision into pieces: First, define the most important questions and then weigh them against your personal goals.

Here's how to think through two of the biggest questions you'll encounter when financing a new car:

Decision No. 1: Big down payment or small one?

In most cases, you will need to decide whether to make a down payment and, if so, how large that payment should be. The answer depends on your objectives and available cash.

Let's say that you've decided on a $30,000 car, and you're approved for a five-year loan at 3.00% APR (annual percentage rate).

What's important to you: Lower monthly payments or paying less overall?

The down payment will help determine the size of your monthly payments. If you have limited savings, you may need to put down a low sum or forego the down payment entirely, in exchange for higher monthly payments and paying more total interest. A lower down payment may also be best if you have the cash available but prefer to put it to a different use, such as saving for retirement or a new house in the future.

On the other hand, a larger down payment could make more sense if you wish to pay less interest overall and enjoy lower monthly payments along the way.

In our $30,000 car example, let's say you're deciding between a down payment of $5,000 or $10,000.

If you choose to put down $5,000, you will make 60 monthly payments of $449.22 for a total cost of $31,953 over the lifetime of the loan.

If you put down $10,000, you'll make 60 monthly payments of $359.37, and your total cost will be $31,562.

Overall, the larger down payment saves you $391 in interest and takes $89.85 off the top of your monthly payment. So consider whether the interest savings justify putting down more money now. Also think about which monthly payment works best with your budget and expected cash flow over the next five years.

Decision No. 2: Lease or buy?

If you intend to keep your car for a long time, taking out a loan is usually a better option than trying to buy at the end of a lease period. But the decision gets trickier if you expect to keep the car for only a few years. Leasing is designed for that scenario. But when you crunch the numbers, is it a better choice than reselling your car as soon as your loan is up?

What's important to you? Lower monthly payments or paying less overall?

Assume you've chosen to make a $2,000 down payment on your $30,000 vehicle, and now you need to determine which is better: a 36-month loan or a 36-month lease.

Assume your monthly payment on the loan is $814.27. At the end of the loan period, you will have paid $31,314 and own the car. If you are then able to sell it for its expected value of $17,600, your total cost for the three years of use is $13,714.

By contrast, assume the lease payment is only $356.27, or less than half the regular loan payment. But at the end of the lease period, you have to give up the car and you will have paid $14,826—$1,100 more than in the loan example.

However, there are other issues to consider in addition to total cost. For instance, would a low monthly payment work better for your budget, freeing cash that you could put toward your credit card or other high-interest debt? If so, you may come out ahead with the lease.

Keep sight of the big picture

Virtually any form of financing will push the total cost of your vehicle above its selling price, so it's important to calculate that figure—and how you will pay it—before making any decision. Always take a hard look at your expected monthly payment to gauge whether you can realistically work it into your budget. Taking the time to match your situation and needs with the right payment option is the best way to keep your finances on track so you can relax and enjoy your new set of wheels.

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