Let's talk about cars, shall we? For some of us, every so many years, we head to the dealership, sit down with a salesperson, pick out a shiny new car, work out some details, and drive off.
We don't think about how much we're spending, or how much the monthly payments are actually costing us over time. In fact, it's designed that way. When we buy a new car versus a used car, we're giving up a lot of money.
In this post, I'm going to talk about buying a new car versus a used car, what it's costing you, how you can save money on a used car, and how much that money will grow down the line.
The Argument for Getting a Pre-Owned or Used Car
Car shopping can be fun and exciting. New cars are shiny, flashy, and have no miles on them.
But here's the thing. That's what they want you to think. Car salespeople sell you the dream while secretly robbing you of your hard-earned cash.
In fact, the second you drive a new car off the car lot, the car depreciates over 10%. Instantly. So if you put less than 10% down, you are underwater from the very beginning!
Let's take two cars, for example, my and my wife's two cars. We bought my wife's car brand new – a Hyundai Elantra.
The salesman did a good job talking us up, and I will admit we tacked on some additional expenses to the final balance that was definitely unnecessary. All in all, we paid $22k for that car, before taking into consideration interest payments over the loan.
The Elantra drives well. My wife loves it. The thing is, two years after we purchased that car, it's Kelly Bluebook value had dropped to under $18k. We lost approximately 18% of the car's value after 24 months – easily.
Now let's take a look at my car. I drive a 1998 Chevy Corvette and bought the car in the Fall of 2018. I did a better job of negotiating with this one over the Elantra.
The car was for sale by a dealership that was months from closing its doors due to the owner retiring. Winter was approaching, and no one drives a Corvette in the snow – this car was not going anywhere.
I was able to pick up this 20-year-old car with only 56k miles for $10,000. The sticker price of this particular 1998 Corvette IN 1998 was approximately $50,000, so it has already depreciated 80%. A brand new corvette of approximately the same configuration is between $60,000 and $70,000 now.
“Hmm, Bo. That sounds like some good luck. Luck isn't practical. How am I supposed to get a good used car?”
Shop Around On Sites Like Carfax.com
Many websites exist where you can look through hundreds if not thousands of used cars and find one that matches your budget and what you're looking for in a car. I found my Corvette on Carfax.
For those who are drowning in debt, the last thing you want to do is take on more debt via an auto loan. Don't let that car salesman tell you that “it's ONLY $285/month because you can pay it off over 72 months.”
In those 72 months that you're paying off your car, you are racking up interest, and your car is depreciating at a terrifying rate.
“We're offering 0% financing today only! You won't pay a dime in interest!”
When you finance at 0%, your financing costs are rolled into the price of the car. That means you are still paying for the financing even if you're not shown an interest rate.
By shopping for a pre-owned car or a used car, you could save thousands or even tens of thousands of dollars.
Imagine saving $10,000 by buying a $15k certified pre-owned car versus a $25k brand new car. What would you do with $10,000?
Invest The Money You Would Have Spent On The New Car
I'll run two scenarios since two scenarios make a lot of sense for the average buyer. In scenario one, you spend $15,000 on a pre-owned vehicle instead of $25,000 on a new car.
You pay $15k in cash and save $10,000 upfront. You invest this $10,000 into an S&P 500 index fund for 10, 20, or 30 years. This is approximately how your money grows at 9% per year.
- 10 Years Later: $23,674
- 20 Years Later: $56,044
- 30 Years Later: $132,677
In scenario two, you finance your $15,000 vehicle because you can't truly afford either the $15k car or the $25k car. Let's assume the APR of the loan is 6% over 60 months. Your car payment on the $15k car is $289.99, assuming no money down, and your car payment, with the same term and rate, on the $25k car, would have been $483.32.
Therefore, you are paying $193.33 less each month for 60 months (5 years). Let's say you invest that amount each month for 5 years and then never invest a dime more. Over 5 years, that amount comes out to $14,691 and then after a total of 10, 20, and 30 years, you have:
- 10 Years Later: $22,604
- 20 Years Later: $53,512
- 30 Years Later: $126,683
When you invest the monthly difference between the two payments, you still earn nearly as much as if you had simply bought the pre-owned car straight-up. What's to note here is the massive savings over time when you purchase a car that's significantly less money.
What you have to ask yourself is: Do you need to buy a new car or can you buy a used car?
How Much Car Can I Afford?
There are a couple of ways to determine how much car you can afford, and this comes in handy when trying to save money by getting a used car.
- No more than 15% of your monthly take-home pay should be spent on car payments – this includes loans and maintenance.
- Sam of Financial Samurai suggests that you should never spend more than 5% of your net worth on a car. This is especially true for high net worth individuals who might have limited income in comparison.
To the first point, if your take-home pay is $60,000 or $5,000 per month, then your car loan plus all related expenses should not exceed $750 per month. If you spend $200 per month on gasoline and don't count any other expenses such as registration, inspections, oil changes, tune-ups, and so on, you would be limited to an absolute maximum of $550 per month car payment.
I would argue that this is still too high.
According to Financial Samurai's guidelines, if you wanted to buy a $25,000 car, you would require a net worth of no less than $500,000. This feels more aligned with how I feel about buying a car nowadays – even if truth be told, I haven't followed this in the past.
Perhaps the truth is somewhere in the middle. Somewhere between 5% of your net worth and 15% of your take-home pay (not forgetting to include maintenance and other expenses aside from the loan).
Famous radio host and personal finance expert Dave Ramsey would recommend that you never take out an auto loan because paying interest on a depreciating asset makes zero sense. However, I'm inclined to agree that sometimes you need a car and don't have the capital to pay all at once. In this case, I recommend getting a pre-owned or used car and not putting yourself in a further financially risky situation.
What To Do If You Bought a New Car That You Can't Afford
The most simple answer to what to do if you bought too much car is to sell it and buy a more affordable used car. But it can be more complicated than that.
There are many scenarios you could be that affect the outcome of what you should do if you bought too much car, so I will list a few possibilities.
- Sell the car and buy a used car: This works if you have a large loan balance still or if your car is still worth most of its initial value.
- Pay down your car loan as fast as possible: Use this option if you have a high interest rate or long loan term. Free up money by eliminating your monthly car payment.
- If you've bought the car in the past 30 days, you may be able to return it. Return the car and get a car that you can afford.
I once bought too much car. Way too much car, I might add. I was making $50,000 per year as a software engineer in 2007, and my wife was job hunting. We had just gotten married and just purchased a condo.
We had credit card debt and a mortgage totaling over $150k, Genius me bought a Pontiac G6 GT which cost me around $26,000. I financed it over 48 months and put $4,000 down.
It took me several years to realize my mistake, and by the time I got rid of it, the value had dropped significantly, and there was no real way to recover. I ended up trading it for another car, and then I traded that car plus cash for an SUV that I drove for several years.
I want to say that my and my wife's weak spot, financially, has been cars in the past. We had upgraded a few times when we definitely didn't need to. The bling of a new car is just so tempting.
But sometimes, it's okay to buy a fancy car. I'll talk about that below.
Hidden Costs of Buying a Car
- Car Insurance: When you buy a new car, you have to get car insurance right away. You may not even know what the insurance rates are currently at. You may end up agreeing to buy a new car and then buy the insurance where, surprise, the insurance quote is higher than you expected. Shop for insurance before you shop for a car. Find out your expected rate to make sure you can afford both the car insurance and the car payment.
- Extended Warranties: Be careful when buying an extended warranty. There's a good chance that you don't need it. You can save money on a used car from both the sale price and from not adding on common things such as an extended warranty.
- Luxury Add-ons: Dealers will fluff up your car with add-ons you likely don't need. This can include expensive floor mats, special-plated pedals, and many other exterior and interior add-ons that you either don't need, or you can get for a lot less at an auto store. Buying a used car with exactly what's included saves you the temptation of adding options that aren't necessary.
- Gas Mileage: Do your research before buying a new or a used car. A car with poor gas mileage could cost you a lot over time if you use the car often, such as commuting to work.
When Is It Okay To Buy a Fancy New Car
Sometimes, a fancy car is in order. I drive a 1998 Chevy Corvette, which is, in my opinion, a fancy car. I was in the market for a Corvette for about a decade before I bought it.
Here's the thing about my car – As I said above, a new Corvette can run $60,000 to $70,000 easy. I definitely don't have that kind of money to spend on a car, let alone would I want to own a depreciating asset of that magnitude (unless I was multi-millionaire perhaps).
By keeping an eye on the auto market for years and mixing a stroke of luck when I saw this 1998 Chevy Corvette with 56k miles on it for only $10,000, I immediately jumped on it.
Am I suggesting you wait a decade for your dream car and rely on luck? Nah, that's not fair to you. Sometimes a dream car is in order.
One particular time to buy a dream car is if you can buy it without financing using money you don't normally get. This could be from a bonus at work, part of an inheritance, or any other windfall of money. Of course, this makes more sense to do if you have no debts besides your house.
Wrapping It Up
Up until a couple of years ago, I always have, and arguably foolishly, bought brand new cars. I totally get it. They're shiny and blingy. But, they're not worth it (most of the time).
If you're struggling with money and debt, and a car purchase is coming up, it's a good idea to consider a pre-owned or used car. It may not seem like the “hip” thing to do, but what's more hip – a used car and having money or a new car and being broke?
Until next time!