Cars, cars, cars; I really like cars. And I’m not alone, most Americans do. According to the inter-webs, we like them too much. The average car payment in 2017 (www.thebalance.com) is $479 with an average loan of $30,032 over 68 months (that’s over 5 and 1/2 years, yikes!). Over 50% of used cars are financed and over 85% of new cars are financed.
My philosophy is a little counter to conventional wisdom but I hope you will indulge my strategy as I hope it helps you make a smart choice on your next vehicle.
Let’s start with my top 5 tips and then I’ll add some color after that for those of you with the stamina to keep reading.
1) Don’t buy a new car; unless your net worth is already in excess of $1 million, I strongly advise you to buy a gently used car. This allows you to avoid the depreciation that occurs as soon as you drive it off the lot. This loss of value is quite excessive – especially the first couple years of ownership.
2) Don’t lease; numerous studies (including edmunds.com) have proven that this is the most expensive way to “finance” your transportation needs. I’m sure there are a couple exceptions (there usually are) but the average consumer shouldn’t even consider a lease. It’s simply too profitable for the dealerships/manufacturers, which is why they push them so hard. I think roughly 25% of consumers opt for a lease – that’s way too high – be smarter about your next vehicle. It’s also a convenient way for many to get a new car they really can’t afford (by focusing only on the monthly payment). In short, don’t sign a fleece – it’s complicated, costs way too much and greatly limits your options both during (e.g., mileage) and at the end of the lease (e.g., surrender value). Leases don’t have to disclose the “real” interest rate but it’s estimated to be 14% (Dave Ramsey). Don’t bet against the big car manufacturers – it’s like betting against Vegas (the house almost always wins!). The big depreciation (loss in value) is “baked into” your lease payment.
3) Don’t limit your focus to the monthly payment. Focus on the life cycle cost of the vehicle. What is life cycle cost? It’s the total cost of ownership over the time (e.g., 5 years) that you own the vehicle, this includes: principle and interest payments, fuel, insurance, maintenance, depreciation, etc. Edmunds.com calls it “total cost to own”, for starters I recommend you go there and do some research on any cars you are considering. Life cycle cost is the best way to measure the value. Remember, price is what you pay, value is what you receive.
4) Don’t buy a vehicle you can’t afford. Per mylifeandfinances.com you shouldn’t exceed 20% of your annual income on your next vehicle. For example, if your annual salary is $100,000 then you shouldn’t spend more than $20,000 on your next vehicle. If you salary is $50,000 then aim for a $10,000 ride. I think this is a really good guideline to avoid spending too much on a depreciating asset – it’s an expense not an investment! Over time, that new vehicle you bought will decrease your net worth – that’s a deal you don’t need!
5) Do your research and buy a car that is reliable, safe, and relatively fuel efficient, but make sure it suits your needs (e.g., don’t buy a suburban if you don’t have any kids). I recommend you start with recommended vehicles from consumer reports. Research the make and model and choose vehicles with a clear record of being reliable and safe. “The millionaire next door” says to avoid foreign luxury cars – instead opt for a domestic (e.g., Chevrolet) car that you can either pay cash for, or at least pay off in the next 2 to 3 years. Your vehicle isn’t a piece of jewelry, it’s a resource to safely get you from point A to point B.
5 more tips, because I’m that kinda of guy
1) I recommend you buy your next vehicle from carmax. They aren’t paying me for this endorsement – I’m just saying there a number of shady used car salespeople out there who don’t have your best interest in mind. If not carmax, then I recommend a certified used vehicle in order to ensure you aren’t buying a repair nightmare. Don’t buy somebody else’s problem.
2) I recommend you sell your current vehicle to carmax. They will buy your vehicle regardless of whether you purchase your next vehicle from them or not. This is cleaner and avoids any confusion that can occur when you trade-in your vehicle. Do these 2 transactions separately and make a smart (non-emotional) decision both times. Do your research and determine the value of your existing vehicle, I recommend edmunds.com or kbb.com before you visit carmax. I also recommend you remove all your personal items and have the car professionally cleaned/detailed before you get their offer. This will only take 20 minutes and is significantly more convenient than putting an ad on craigslist, I’m just sayin’.
3) Don’t keep the vehicle too long and get some crazy high repair bills on an unreliable vehicle – this could leave you in an unsafe situation (e.g., on the side of the road at night) and maybe result in missing work too. Unreliable transportation is a ticket to losing your job and could turn out to be a financial disaster. Vehicles are designed to last 10 years or about 200,000 miles. If you are careful and do the proper maintenance you could possibly get 15 years or 300,000 miles. After that, however, you are borrowing trouble. Anticipate when this will occur and set aside money each month into a car fund so you can pay cash for your next vehicle. It shouldn’t be a surprise when your vehicle “expires”. Be like the boy scouts – be prepared!
4) Don’t skip the required maintenance (including tires). Read the manual and find out what the manufacturer recommends for maintenance. Follow the manufacturer’s schedule, not the dealership’s – they will many times recommend extra maintenance that only serves to add to their profits.
5) If you realize you have a car that you can’t afford – sell it!Don’t keep it. It will continue to depreciate. Sell it and buy a gently used car that you can afford. Remember the 20% annual salary target.
Final thoughts
Don’t trade often – keep your vehicle for at least 5 years – preferably 6 or 7 years. I personally would not spend more than the vehicle is worth on a repair. For example, if the blue book on your vehicle is $1,000 and you encounter a $1,200 repair – I would scrap the car rather than invest more into a car than it’s worth (do the math – might be better off selling the car as is).
If you have to finance your next vehicle, opt for a credit union loan (if you can); their rates and fees are usually much lower than the national banks. Try to pay off your car loan (insist on a simple interest loan) early (2 to 3 years) and then start setting aside money each month for the next vehicle (pay cash), in order to be debt-free!