Do you want the truth? Neither. The most cost effective option is truly to go without a car. Most people will not consider this an option and certainly, it seems most communities in the US have been built with the car as centerpiece making it impractical for many families to get around without one. My goal of financial freedom includes downsizing our home in the near future and included in my next home choice will be the consideration to be within biking distance of grocery stores and work. But for now, I use a car to travel from my rural home to work.
My philosophy (and one of my Key Principles) has always been to buy used cars and to pay for them in cash. The top reasons for this are so that I don’t get hit with the big up-front depreciation that new cars experience and so that I don’t pay any interest on the amount I’ve agreed to pay for the car. Let’s be clear about this: a car in this scenario is a necessity, not an investment. You will not be selling your car 10 years from now for more than you agreed to pay for it today. The only thing for certain about a car is that it will cost you money. Your goal should be to get the most cost effective vehicle that you can and to use it until it is impractical to use anymore due to excessive maintenance costs or safety issues.
According to Edmunds, if you buy a new car today it will only be worth 37% of its original value in five years. Let’s say you decide to buy a new car for $25,000. You don’t have $25,000 lying around so you decide to finance the car over 5 years. The interest rate on a car loan is only 2% anyway, so why not? You use a handy car loan calculator to see that your payments are $438 a month and you drive merrily off in your shiny new Whahoosit SUV. In one year’s time, you have shelled out $5,300 in car payments (which includes $450 in interest – a real bargain!). Over that same period the car has lost more than $3,100 in value (it’s really more than that since the car loses value more rapidly up front, but I just assumed straight line depreciation in the first five years). Another way to look at this is that in the first five years the car is losing value at a rate of about $260 a month. All while you are paying $438 a month to own it. Does that sound like a good deal to you? To me it sounds like you are running a deficit of close to $700 a month for this car. Yikes!
But you can take heart because at the end of those five years your car payments will stop (yippee!) and you will have paid $26,280 for a car that is now worth $9,250 (provided you’ve taken good care of it). That’s a 65% loss in 5 years. And don’t forget to throw in all those maintenance costs when you’re adding up the true cost of the car. You might have done better trying your luck in Vegas.
Also according to Edmunds, a car is worth between 50% and 60% of its original value after 3 to 4 years and this is when I tend to buy them. A big chunk of the depreciation has already happened by this point and the car depreciates at a slower pace from here on out. Don’t get me wrong, I’ve still paid a heap of money for something that is worth less every minute and it just kills me. But for now, this is what we are doing and we know that we are going to be making a change in the future. Similar to the way people view mortgages as a given expense in life, many people do the same for cars and the loans that go along with them. It’s important to realize that you can live differently by paying off your mortgage and it is certainly possible to live without car payments. If you look at the car buying process from the angle of how much you are paying up front combined with the added cost of depreciation, you may just decide that a used car or even better, no car, is the right choice for you.
So what do you buy? New or used?