Car Buying Principles to Save Truckloads of Dough 5

Transportation is generally one of the larger expenses anyone faces. However, it can be managed to lessen the impact on one’s spending and improve finances. As discussed in my recent article about purchasing a used car and the analysis behind my decision http://www.networthsnowball.com/2013/02/16/un-pimp-my-ride/ , I wanted to highlight a few takeaway principles that should be employed to save the most cash:

Buy used

• The scary thing about a new car purchase is that a general rule of thumb is that a car loses 20% of its value when it’s driven off the lot!! Crazy! So for a new car costing 25,000 off the lot, there goes $5,000 hard earned dollars evaporating in a matter of minutes. Furthermore, the car will continue to depreciate on average between 10-15% thereafter. So the sweet spot is to find a used vehicle many years old (5-10) where the depreciation has made the largest impact already. Preferably, this vehicle will have less than 100,000 miles. In the example of the $25,000 new car, after four average years of depreciation, the vehicle will be worth less than half of the original sticker price! Vehicles can easily reach and exceed 200,000 miles with proper maintenance so it makes tons of sense to purchase a used car.

 

• Additionally, in states with higher sales tax percentages, such as my home state with over 9% sales tax, the new $25,000 vehicle will make for a generous $2,375 donation to the state government to squander how they so choose.

 

•  Finally, the old mantra applies that one should never finance a depreciating asset. However, 90% of people don’t follow this edict as the National Automobile Dealers Association (NADA) maintains that 90% of new vehicles purchased are financed. This means that in addition to the huge depreciation costs and tax these people are absorbing by buying new, they are also paying large sums of interest. On a 6 year, 6% loan for this $25k vehicle, the purchaser will spend nearly an additional $5,000 on interest payments alone

Let’s evaluate and compare the purchase of a new car and the total cash outlay vs. the purchase of a used vehicle. Slick Sam purchases the $25,000 vehicle mentioned above on the loan described above with our 9+% sales tax. Slick Sam’s total cash expenditure for the new car purchase (excluding operating/maintenance costs) will be approximately $32,375 after the 6 year loan is paid off. Sadly, Sam’s Car is only worth about $10,000 at this point but he’s ready to upgrade to a new beamer. Consequently, Sam has paid $22,375 for the priveledge of driving his vehicle over the six years, not even considering the operating costs of the vehicle.

Sam’s neighbor, Frugal Fred has been admiring Sam’s car and is ready to replace his 20+ year old vehicle. Fred jumps on the opportunity to purchase Sam’s relatively new vehicle for only $10,000, which is $15,000 off the car’s new window sticker or 60% off! Fortunately, Fred has studied the Consumer Reports and knows that even though the car has 60,000 miles, he should be able to drive it trouble free for another 100,000+ miles. Better, yet, he doesn’t have to pay loan interest as he pays in cash, and pays less than $1,000 in sales tax compared to the $2,375 that Sam paid on the new vehicle. Even if Fred opts to get rid of his vehicle after the same six year period that Slick Sam, his car will be worth nearly $5,000.  This means the priveledge of driving the used vehicle for 6 years cost Frugal Fred only $6,000 compared to the $22,375 that Slick Sam paid!

Although this is just a silly quick example, it’s demonstrative of the vast savings unlocked by purchasing a used car. The stakes prove even more lofty when you start talking about the purchase of luxury vehicles or pricy pickups.

Pay with cash

• As mentioned in the example above, car buyers will save $$$ by purchasing cars with cash on interest savings. However, buyers will also save more because the promotional 0% and 1% offers from the dealers come with a hidden price. They eliminate other discounts or rebates that would otherwise apply. So forgoing the promotional interest rate usually entitles the purchaser to more $$ in rebates when buying new.

  

• Furthermore, when financing a car, due to the large early depreciation dollars, the car will most often be “underwater” for the duration of the loan. This means that the car’s retail value is less than that owed on the car including interest. This creates amplified problems when someone is displeased with their vehicle or needs to sell it for other reasons and then they are hit for additional cash since they are under water for the difference between the car’s actual value and the bloated financed commitment.

 

Focus on reliability

• When buying a used car, one can save themselves much angst and cash by thoroughly researching Consumer Reports to assess a used vehicle’s reliability. Their consolidated database of information is more relevant than anecdotal evidence from friends as it provides a much larger sample size to analyze.

Focus on MPG

• Fuel Prices are a major chunk of driving related expenses. There are a multitude of used cars available that offer over 30 MPG combined ratings at reasonable prices. Let’s examine a couple used vehicles at current fuel prices around $3.50/ gallon with help from the EPA’s fuel economy rankings located here: http://www.fueleconomy.gov
  • 2006 Dodge Charger 3.5 L, 6 cyl, Automatic 5-spd, Regular Gasoline
  • 17 City/24 Highway/20 Combined
  • 2006 Honda Civic 1.8 L, 4 cyl, Automatic 5-spd, Regular Gasoline
  • 26 City/36 Highway/30 Combined

 The 2006 Honda Civic in the example above saves ~6 cents per mile driven in fuel costs over the Dodge Charger noted. So, for the 10 MPG bump in combined fuel economy, let’s look at the possible fuel cost savings:

• 1,000 miles= $58
• 10,000 miles= $584
• 100,000 miles= $5,845

Clearly, vehicle MPG plays a huge role in managing the costs of vehicle ownership and close consideration should be placed on this factor.

Don’t focus on appearance or keeping up with your peers

There is a big peer pressure environment for many newly hired college graduates to go and purchase a vehicle since “they’ve arrived” and have begun their careers. I’ve seen countless peers go out and purchase or I should say finance $50,000 lifted 4×4 pickups, or even luxury BMW and Mercedes sedans. Meanwhile, I spent $1,500 cash a few months into my career out of college to purchase a 13 year old sedan getting decent fuel economy. Now, I may have been a laughingstock to my peers, but I’m okay with laughing right to the bank with the savings .

See the example below which shows replacing the payment on my peers’ purchase of a $50,000 fully loaded brand new 4×4 pickup financed over 6 years at 6% APR Interest Rate but instead placing this $828.64 monthly payment into a Vanguard Stock Market Index Fund earning an average of 7% interest. 

 After the duration of the loan, my investment would be worth the $73,882 noted above compared to just under $18,000 value for the pricy pickup at standard depreciation rates. At the standard Social Security Retirement age of 66, my decision to forgo an expensive luxury vehicle and purchase a no-frills commuter for cash after starting my career has blossomed into an incredible nest egg of $2,921,249 thanks to the glory of compound interest. I’m pretty happy with my decision!