We’re in the middle of a series all about frugal living right now. Today, my husband, Ben, is going to share about why buying a new car could be the wrong choice for your family.
Types of Expenses
Just like all of you, our vehicles represent one of the largest expenses in our family budget. However, it is different in many respects from our other large expenses.
Most of our largest budget categories represent planning for the future — saving for retirement (15% of our income) and saving for college (8% of our income). These aren’t truly “expenses” though, because they are appreciating assets, which means the value will increase over time. Our mortgage also fits into this category, because while it is an “expense,” since we are paying down the debt, our net worth is also increasing here.
The rest of our major expenses — health care, insurance, food, I consider to be required necessities. Unless any of you are eating filet mignon for dinner every night, have a $10 million life insurance policy, or you have a personal staff doctor that comes to your house to treat every illness, then these are minimum, necessary expenses for you as well.
A Necessity Level Car
Where does the car fit in?
Unlike all of the expenses I’ve already outlined, a car is a unique type of asset/expense. Unlike investments, a car is a depreciating asset, meaning unless you own a mint condition car from the 40′s or 50′s, it will lose value every single day you own it.
Also, like food or housing, it is a “necessity,” but virtually no one is driving a “necessity level car.”
What do I mean by that? Americans have a love affair with cars. To most, a car is a status symbol and driving an expensive car is something they aspire to. For many working professionals, unless you are driving a BMW, Lexus, Acura, or other “luxury” brand, somehow you aren’t successful.
Stay-at-home parents are sometimes even worse. One of our neighbors drives a Porsche SUV, a car that costs between $50-100,000 depending on the configuration, and they live in a house that is worth around $120,000. Additionally, their other car is a luxury model too. Their two cars cost (note I didn’t say worth) nearly 75% of what their house did.
The situation I’m describing is not a “necessity level car.” A reliable, 3-6 year old used, commodity car that is worth between $5,000 and $12,000 or so, is what you actually need to meet the basic necessity; anything more than that is your own personal preference.
This leads directly into my first point. The single most common reason that people buy a new car is because they “just want it.” Their current car is getting old, and it just isn’t as nice as it used to be.
While almost nobody will say that this is the reason, most of the “reasons” are justifications of wanting a new car. “Well, it just doesn’t get good gas mileage anymore.” “I’ve just noticed that is isn’t as reliable as it used to be.” While these may be true, there are many cheaper ways to fix those issues than buying a new car. If your default react is, “I need a new car”, then I’m afraid that you’ve got a case of car fever.
Have you ever noticed that car commercials usually feature lots and lots of footage of smiling people driving the car? They usually mention gas mileage and safety ratings, if it is a minivan or SUV, but predominantly it’s all about the speed, handling, off-road capability, and general style of the car that they focus on.
Have you ever wondered why that is? Have you ever wondered why the very last thing they mentioned is the cost? They don’t want you to think about the cost; they want you to make an emotional decision, based on the color, style, and brand of the car, and to worry about everything else after that.
If I told you that I had a great stock tip for you, would you be interested in investing? Fabulous rate of return, I say, you’ll only lose 50% of your money during the first 5 years! Sound like something you want to invest in?
If you didn’t already realize it, a new car, regardless of brand, features, price, or model, will lose between 40% and 60% of it’s value during the first 5 years. Just to use our personal car as an example; a brand new 2013 Honda Odyssey, base model, costs $30,000. After 5 years, that car will be worth around $12,000, or a loss of $18,000 in value (60%).
If you “absolutely have to have a brand new car,” if you “absolutely have to have it in style ____ or color ____,” or if you buy new for any reason, know that your decision will come at an enormous financial cost.
The second most common reason I hear, is that their current car gets poor gas mileage. “If only I had that new _____ hybrid model that gets ___ MPG; that would save us so much money!”
I probably hear some variation of that line when I talk to anyone who is considering buying, or has just purchased a new car. Again, while it is certainly a true statement that nearly all newer cars get better gas mileage their older cars, buying a new car will not save you money. Note that I didn’t say save you money on gas, I said lower the total cost of ownership.
For the average car, the number one expense is depreciation, or the amount of value the car loses each year. The second highest cost is debt payment. The third highest cost is fuel. If you are buying a brand new car, or save money on fuel, you are significantly increasing the cost of depreciation and debt servicing costs, while somewhat minimally decreasing the cost of fuel; overall, this will be a terrible financial decision. Let me give you an example to illustrate it.
Let’s say that you have a 2004 Toyota Camry, the most popular car in America. This car gets an average of 24 mpg, and is worth around $5,500. A brand new 2013 Toyota Camry Hybrid will cost you $27,000, and it gets 41 mpg. This is nearly 60% better fuel economy; think of the savings!
But are you really saving money? That brand new Camry will lose approximately $12,000 of value during the first five years of use. In comparison the 2004 will only lose an additional $3,000 in value with another five years of use. This means if you drive an average amount, approximately 12,000 miles per year, you save save $3,000 in gas by buying the hybrid, but lose $9,000 more in depreciation.
The bottom line is that unless you drive over 26,000 miles per year, it is significantly cheaper to keep driving your current car, even though it has terrible gas mileage. Besides, if you really care about gas mileage, and that is your only concern, just buy a 1998 Chevy Metro, they get 40 mpg as well! If you’re not willing to at least consider the Chevy, then my guess is that better gas mileage wasn’t the only reason you wanted that new car.
I can already hear the counter argument forming in your mind, “but the 2004 Camry isn’t a reliable car!” “A 1998 Chevy Metro, that car would break down every 5 minutes!” That argument is true, up to a point.
It is a fact that older cars are statistically much more likely to break down then a new car; that doesn’t mean they will, it just means it is more likely. In my personal experience, and based on numerous robust studies conducted by Consumer Reports magazine, late model Toyota and Honda vehicles rarely have major breakdowns, even if they are driven for 15 years and have 200,000 or more miles logged on them. Even GM and Ford vehicles made after 2000 are scoring surprisingly well on reliability tests 13 years after they were made.
The three cars I’ve owned (16 year old Honda Accord, 11 year old Honda Odyssey, and 10 year old Nissan Sentra) have never had any major problems (cost more then $500 to repair), although they have each broken down a few times from somewhat minor issues (battery, radiator, electrical system, tires). One thing I was concerned about was that Kate would get stranded on the side of the road with all the kids. For me, I could probably fix most issues, but I don’t want her get stuck in the middle of nowhere. We made the decision to buy AAA for both our cars, so that if a breakdown does occur (it has happen to both of us), we have someone to call 24/7.
For Kate and I, we buy cars that are 5 years old (after they have already lost 60% of their original value), and we drive them for 5 more years (they will lose about another 20% of their original value in the second five years), before selling them again. In this manner, we are trying to balance the extreme cost of owning a new car (depreciation), but still being able to drive a reliable car (not too old).
The other great benefit of this system is, that since the cars we are buying only cost $5,000 to $8,000, we can afford to save and pay cash for them, instead of going into debt. Over the course of our lives, our car buying system alone, will increase our net worth by over $5,000,000 (that is 5 million dollars)! If you think I’m kidding, just watch this video.