Vehicles, after your home, are probably the most expensive item most of us will purchase. That alone warrants careful planning and strategic purchasing to get the most for your hard earned dollars.
New Car vs. Used Car?
What is smartest, buying a new car or a used car?
15.6 million new passenger cars & light trucks were sold in 2013. [Note 1] Car retailers do an incredible job convincing us that we need the latest sleek, blingy car.
Here are some facts about new cars:
1) A new car loses nearly 20% of its value in the first year! [Note 2] (A car loses about 11% of it’s value the moment it is driven off the car lot! On a $30,000 car that means the moment the front wheels hit the street it is now worth $26,700).
2) Vehicles lose between 15% and 25% of their value EACH year for the first 5 years.
3) After 5 years a car has lost on average 63% of it’s value. It is now worth 37% of what you paid for it. (Some cars have lost more than 80% of their value at the end of 5 years! [Note3])
A car has lost on average 63% of it’s value in a few years. However, it will depreciate at a much slower rate the remainder of it’s life.
Wize: Let someone else by the car new and drive the expensive years of the car (years 1-5). Then you pay for, and drive, the inexpensive years!
Still convinced that you want to buy a new car? Ask yourself these questions:
1) Why do I feel like I need/want a new car?
2) What will a new car be able to do for me that a used car will not be able to do?
3) Am I ok with losing as much as 80% of my investment in 5 years?
Borrowing to Buy a Car
How much is wise to borrow for a car? After all it’s just American to borrow money in order to buy a car.
The reality is that it’s NEVER smart to borrow money to purchase a car. Most of us borrow money to buy a car because the car that we think we need (but really just want) is beyond our financial reach. And interestingly the wealthiest people in America, even though they can afford much more, buy Hondas and Toyotas just like the rest of us [Note 4]. Maybe that’s why they’re wealthy?
Practically, why is it not smart to borrow money to buy a car? A car is something that depreciates in value. In other words it goes down in value over the course of it’s life. And it is NEVER smart to borrow money for something that decreases in value.
Remember from above how quickly a car loses it’s value. (Reminder: A typical new car loses 11% of it’s value when driven off the lot; 20% of it’s value in it’s first year; and 63% of it’s value in the first 5 years.)
Here’s an example of the difference of borrowing to buy a car versus paying cash for a car.
Borrow to buy a car
Let’s say you have $6,000 saved and you buy a $30,000 car (which is about $2,500 less than the average price of a new car in 2014).
- You borrow $24,000 to buy that car on a 5-year loan.
- Your payment is going to be $453 a month.
Fast forward 5 years:
- You have paid $27,180 in loan payments (including interest)
- Plus the $6,000 you originally paid, for a total cost to you of over $33,000
- You now have a 5-year old car worth $11,000.
Pay cash for a car
You take your original $6,000 and buy a used car.
- Instead of being in debt and making payments to someone else, you make those same $453 payments to yourself and put them in a savings account.
- We will even assume that you made no interest on your savings, zero.
Fast forward 5 years:
- At the end of 5 years you have $27,180 in the bank.
- After 5 years that $6,000 car is worth approximately $2,000.
- At the end of 5 years you have $27,180 + $2,000 & you can go buy a car worth $29,180 with CASH!
So, with buying the new car on debt at the end of 5 years, I’ve lived in debt for 5 years and at the end have an $11,000, 5-year old car to show for it.
But if I’ve saved, I’ve been in no debt, so if something happened to my income or I needed the resources for something else I had the available resources.
AND I now have a practically new $29,000 car paid off! And the only difference was I was patient for a few years.
Buying a Used Vehicle
So you’ve decided to pay cash for a car, and buy a car that won’t lose value immediately. What’s a smart strategy for buying a USED car?
1) Before you look at any cars you must answer this question: How much money do I have to spend? Start by knowing the maximum out of pocket that you can afford.
Tip: Don’t forget that when you a purchase a car and transfer the title you will have to pay taxes, title and license fees which will add to your cost (In Lubbock, TX for example you pay a 6.25% sales tax + $28 title fee & approx $63 registration fee. 7% is a good total cost estimate where I live.)
These fees will vary in each jurisdiction. Call your local tax office to see what your rate will be. Regardless of where you purchase the car it will be registered in the jurisdiction in which you live.
2) Once you determine your maximum out of pocket then you need to determine the different model car(s) that you are shopping for. I encourage you to narrow it down to 3-5 different models.
A. Is there a specific style (compact car, sedan, mini-van, pick-up, etc) or model (CR-V, Toyota Corolla, Chevy Silverado, etc)
B. One way to take this next step of narrowing down to a few specific models is to use the Consumer Reports (http://www.consumerreports.org) Used Car Ratings. An annual subscription to the online Consumer Reports will cost you $30 but it can be worth it even if you just use the Used Car Ratings section (and this subscription gets you access to all their reports, not just used vehicles).
In the Consumer Reports Used Car Ratings pay close attention to the Reliability Report as it will tell you for each model car what the reliability of the used model is. Here is a sample of the Consumer Reports Used Car Reliability Ratings for a Honda CR-V:
As you can see the Honda CR-V has excellent ratings for nearly every component for every year model. As you look at different vehicles this will give you a great way to compare the reliability of each model.
C. Based on what you find in Consumer Reports narrow your choices to 3-5 vehicles that have good used Reliability rankings. [If you do not use Consumer Reports you can do similar kind of research using the free reports in the next section. You will just have to piece together the information through searches about the different vehicles.]
D. Determine what year model(s) of your car choices fit into your price range.
To find prices for different year model cars you can use:
1) Consumer Reports – each car/year has a Price report
2) Kelley Blue Book (http://www.kbb.com/)
3) Edmunds (http://www.edmunds.com)
4) AutoTrader.com (http://www.autotrader.com/)
I usually look at 2-3 of these as I am determining what year model(s) are in my price range. This pricing also gives me something to negotiate with as I find used vehicles.
Here’s a rundown on using these reports for pricing:
Consumer Reports has a larger, more general price range.
Kelley Blue Book and Edmunds both use more specific information that you input (zip code, mileage of car, condition of car, features of car, etc) to find a more specific average price.
Tip: Don’t get overwhelmed here by all the specifics, just enter in what you think would be average and then when you find a certain car you can be more specific. It will still help you get a great idea of the price range.
AutoTrader shows you specific cars for sale in your City (or a larger area that you choose).
The bottom line is that you should now be able to focus in on 2 or 3 specific year models of the cars you are looking for (i.e. Honda CR-V’s from 2006-2008; Nissan Pathfinders from 2007-2008; or Kia Sorento from 2008-2010)
3) Determine where you are going to look for your Used Car. There are two primary options:
- From a Car Dealership (New & Used dealers both sell used cars)
- From an Individual
The plus side of looking at a Car Dealer is that they have a much greater inventory of cars.
However, there are several positives of looking at cars that Individuals are selling: 1) The prices are usually significantly better; 2) You can speak directly to the owner who has used, and knows, the vehicle which means; 3) You will likely be able to find out much more about the history of the car.
For the reasons above I strongly prefer to buy from Individuals.
Wize: Patience. If you want the best car and the best deal, you MUST be patient. There are thousands of cars for sale right around where you live. If you buy the first one that is shiny and in your price range without going through the steps below you probably will not get the best car & best deal.
4) Finding the Right Car
The steps below are specifically for buying a car from an individual but many of the same steps could apply in buying from a dealer.
I move to each new step only after the step before it checks out.
Step 1: Call the owner and set up a time to look at the vehicle. Inspect the entire car, inside and out. Look closely at the tires and be sure they have ample tread as they are one of the most expensive upkeep items on a car. Look at the spare tire as well and be sure that it is in good condition. Look in the trunk. Look closely at the interior for any damage to the upholstery or other interior components. Look under the hood for any obvious cracked hoses or other signs of wear (I am not a mechanic so I can’t spot most things that would be wrong but I can see any obvious damage or neglect).
Many times there is damage (i.e. dents/missing paint on the interior; damage/wear & tear on the inside) that is excessive for the age of the car and this becomes a price negotiating point.
Wize: How someone has cared for what you can see, can tell you a lot about how they have cared for what you can’t see. If a car is visibly not well taken care of or very dirty, I usually don’t look much more. If they have not taken care of the visible parts of the car then there is a high likelihood that have not taken care of the necessary maintenance that you cannot see.
I also ask lots of questions including:
- Is the mileage the actual mileage on the car?
- Has the car been in any accidents? If so, what was repaired on the car? [You especially want to stay away from cars that have had any damage to the frame of the car. This can compromise the structural integrity of the car.5]
- Do they know of any mechanical issues with the car?
- Has the car had all of the routine maintenance (as instructed by the car’s manufacturer) done on it?
- Why are they selling it?
Wize: This is where buying from an owner can be incredibly helpful. Especially if the car has had only one owner. They fully know the history of the car. At a dealership they are guessing at the full history of the vehicle.
There have been times that I have immediately walked away after seeing the car because I can tell from the outside or inside condition of the car that it has not been taken care of by the owner, or I sense that the owner is not being honest with me about the car.
Step 2: Ask to drive the car. While looking at the car I ask to drive it. I will take it out for 5-10 minutes and see how it drives and handles. I get a feel for if I am comfortable in the car. Are there any components of the inside of the car that would really bother you? (i.e. If you really dislike the transmission shifter being between the two front seats instead of on the steering column; or if like me, you drink lots of coffee and there’s not enough cup holders!).
Again, I am no mechanic so as I drive the car I can’t analyze every noise & clank but I can tell if there are noticeable issues with the engine or the steering components.
Step 3: If I am still interested at this point I ask to see the cars maintenance records and ask for the car’s VIN (Vehicle Identification Number).
The maintenance records will tell me more about how well the car has been taken care of. The main things I look for are if: a) The oil has been changed on a regular basis. b) The other routine maintenance has been done.
Step 4: If I leave feeling like this car is a likely candidate, the next step for me is to go back home and using the car’s VIN to get a CarFax.
I am using the term ‘CarFax’ generically for a history report on the car. The company CarFax made these popular but there are other companies that now provide them online.
These reports have information about the known health of a car. They tell you: 1) If a car has had a significant accident; 2) If a car has a tainted Title (i.e. has a salvaged or junked title because it has been flooded, etc). 3) If it was marked by the state as a ‘lemon car’; 4) Other important vehicle history.
Wize: Generally speaking you want to stay away from all ‘Salvage’ or ‘Junk’ titles. This means that something bad has happened to the car. Most of the time with one of these titles you can not get Collision insurance.
One exception to this is that I did purchase a car for one of my daughters that had a salvage title because of hail damage. Because of the extent of the hail damage the car had been totaled. But the interior was like new, it only had 40,000 miles and my mechanic said that the engine was in great condition. My daughter was good with driving a car with little dents all over it because she got it for less than one-half the book value! (Book value referring to the value in Kelley Blue Book.)
Wize: Another factor that will show up on the car history report are cars that have previously been rental cars. The market is flooded with rentals and I stay away from these as well. Rental cars have a reputation for being driven very hard and renters do not have a good reputation for taking care of the cars that they rent.
Carfax is the leading company producing the car history reports but they have become more & more expensive. There are several other online companies who produce them. Below is an example of the front page of one that I purchased from a different online company.
Step 5: If everything checks out to this point then I let the owner know that I am very interested and ask them if I can take the car to a mechanic.
A mechanic usually charges $75-$100 to fully check out the engine and other mechanical components. I think this is vital when buying a used car so that you can feel good that there are no critical, expensive deficiencies that can be easily diagnosed.
If the mechanic does find issues that would have cost you hundreds or thousands of dollars then you can walk away from the purchase and your $100 will have been very well spent.
Step 6: The last step is to negotiate a fair price. I take into account the values that I found in #2 above. And then other factors:
- The wear and tear of the car
- The condition of the tires
- The number of cars currently on the market (if there aren’t many cars available, this will drive up the prices and if there are many cars available this will drive down the prices)
Don’t be hesitant to negotiate with the owner but if it’s the car that fits your needs and your budget then don’t hesitate to pay a fair price.
Buying a vehicle is one of the most important purchasing decisions that most of us make. Understanding the issues of New Car vs. Used Car, Borrowing vs. Cash, and then having a process to make a wise car purchasing decision will all help contribute to making a decision that helps lead to financial freedom!