By Kevin M
Question: is a car an asset or a liability?
That was a theory question in a sophomore level accounting course I took in college way back when. After some debate among the class, the professor confirmed what we all knew, that the technically correct classification is “asset”, but felt compelled to add, “Of course, in the real world, we all know that automobiles aren’t assets at all, they’re liabilities that cost money and continually drop in value from the moment you drive them off the dealer lot.”
Most of us know this to be true intellectually, but does that reality guide our decisions at buying time?
Cars represent a structural expense, that is, an expense that’s mostly a consequence of an underlying cost structure created at the time of purchase. Once we’ve made the initial purchase, we’re largely stuck with the expense level over a period of years. It’s in our best interest then to make the most intelligent decision at the time of purchase.
With that thought fresh in our minds, I believe used cars are the better choice for most people in most cases.
The new car trap
Buy or lease a new car every 3-5 years and you’re guaranteed of one thing: you will never get out of debt. You will always…
- pay the new car premium,
- have monthly payments to make, and
- dedicate a disproportionate amount of your income for auto expense, since debt service, insurance and ad valorem taxes are higher on newer vehicles.
Cars always decline in value and you can never come out on top in this game because the deck is fully stacked against you from the start. According to Buying Advice, the average new car will lose up to 20% of it’s value in the first year and 10% of it’s value in each of the next four years. That’s a 60% decline in value within the first five years of ownership.
In 10 Ways to Buy a Car Without Getting Ripped Off we discussed another dilemma often afflicting frequent car flippers: being “upside down”—or—owing more on the car than the car is worth.
Many owners of late model cars are in this situation because of extremely low or non-existent down payments, immediate and continuous depreciation of vehicle value, and dare we say it, cutting a bad deal on a car in the first place. Still another cause is the possibility that an owner may have bought a new car while still being upside down on the previous one. The hole only gets deeper when the process is repeated!
Used car advantages
Let’s face it, buying a new car is a rush! The newness, the cutting edge design and technology, the idea of being the original owner, the new car smell; alluring, all of it!
However, if we’re going to talk dollars and cents, buying used comes out as the solid better deal.
- Since there’s no manufacturer to pay, used car prices are more negotiable
- If you’re not particularly savvy when it comes to cars, the ramifications of making a bad deal on a $10,000 purchase price are likely to be far less severe than on a $25,000 car
- The possibility exists to purchase direct from a current owner which can produce an even better price than working with a dealership
- Since much of the depreciation on new cars occurs in the first two to three years, used car prices are closer to book value (Car Price has a good tool to estimate depreciation)
- Since used cars can be bought closer to book value, and depreciate more slowly than new cars, it will be easier sell and cover the attached loan, should that become necessary
- The relative size of a down payment from a $3000 trade in will be proportionately higher on a used car at, say $10,000, than on a new car at $25,000 or $30,000
- On average, depreciation slows after a car hits five years old
- It can be more cost effective to buy a better quality used car than a cheap new car
- Loan balances will be smaller due to the lower purchase price
- A lower purchase price holds the possibility of paying off the loan early, or for buying the vehicle for cash, eliminating the need to carry debt
- Do you really want your 16 year old cutting her teeth in a new car???
- The lower overall cost structure of a used vehicle will afford more options at a future time when income may be in doubt
And here’s one we don’t often think about: even if you buy a car brand new, after a year or so, it’s not new anymore!
The bottom line
The average new car today costs roughly what it cost to buy an average house in the 1970s. One of the problems with the price structure is that there’s little room for people of modest/middle class means to buy a new car, or at least to do so without taking on an outsized debt. A $20,000 debt on a mid-priced car is hardly unusual, and that’s a debt on a depreciating asset!
Assuming a five year term and a rate of 10%, the monthly payment on a loan that size is about $425 per month. Some families have two of them, or $850 per month—that’s not a car payment, that’s a small house payment.
Just because the bank says you can “afford” to carry such debt, doesn’t mean it’s in your best interest to do so. $850 per month is over $10,000 going out the door each year to cover debt service, and that doesn’t even include the costs of fueling, insuring, maintaining and repairing the cars. Can you really afford that?
Given that there’s very little selection available for new cars for under $20,000, the better option for many people will be to buy a used car. A two to three year old car can have many of the benefits of a new car, but can be had for 30-40% less. On a $25,000 car purchased brand new, that’s a savings of $7500 to $10,000.
How might it impact your future financial position to have that much more money in your bank account than in your car?
Can you think of any other reasons a used car would be a better choice than buying new? Do you hold the opposite opinion, that new is the way to go?
What are your thoughts on the 0% loans for new cars. Essentially you are getting credit for free, but you still have the debt and depreciation.
Jason @ Redeeming Riches´s last blog ..3 Easy Ways to Help Others
Jason – 0% interest is certainly better than a traditional loan, but I’m of the opinion that it’s mostly a lure to get us to buy cars we don’t necessarily need. IE, “it’s too good to pass up” so we’re steered into a new car when maybe a used car is a better option.
With car loans, because of the shorter term, interest isn’t as significant a portion of the payment that it is with mortgages. You still have a debt, and that’s the real issue. You still have more capital sunk into a depreciating asset.
Awesome analysis! Reminds me of Dave Ramsey tip about how to drive free cars for life. It takes a lot of courage and work to decide to give up car-loans. Super cool!
Deacon Bradley – I’ve known people with fat bankrolls who drive older cars with no debt, and I think that’s the way to go. My wife and I have no car loans, and after years of having a loan on one or both, this really feels good.
Maybe the car you’re driving won’t impress people, but you have more control of your money, and that’s a better way to live, in my opinion.
Big picture, I think our objective should be to be debt free and as liquid as possible. That’s a position of strength from which all kinds of options surface. There may be a few things we have to give up to be in that position, but it’s a goal well worth pursuing.
Thanks for the great tips on buying cars.
What are your thoughts about leasing a car for business with no down payment, then keeping it for 2 of the 3 years, then selling it on the open market for a “profit”?
This is what I’m currently doing. I have one LLC set up for my business. I am a partner in another business where I do SEO work on a monthly basis. My “payment” is in a gas reimbursement for mileage I put on the car each month due to travel for the SEO work.
My plan is to sell the car this year, pay off the lease, and have a bit of extra money to then buy a nice used car for cash or set up another lease option like the one I’m currently in.
Hope this makes sense…
Advice? Thoughts?
Nate´s last blog ..5 Simple Steps to Twitter Viral Marketing
Nate – I’d not heard of anyone doing what you’re doing, and it sounds interesting.
First, you’re doing it as a part of your business, so it’s kind of a different situation from what the average person would do, or should even be recommended to do. Second, it sounds like a process you’re familiar with, and if you can do it profitably, go for it.
I see no down side if it can be done profitably. My guess is you’d have to make a solid deal on the lease up front, being able to buy it out for less than what you know you can sell it for. Great deal if you can make it happen.
Buying a new car or used both have their importance but it varies from buyer to buyer. If an business man wishes to buy a new luxury cars than its easy for him to buy it as he has sufficient funds where as a person with no or less funds is not able to buy it due to lack of finance.
Kids would be a big reason to buy a used car instead of a new car! Kids are just active and you want them to be that way!
If you have a new car, you don’t want it scratched up by the kids. But if you have a used car… anything goes!
I wish I had known this before I bought our Toyota Sienna new back in 2003. Now it looks like it’s been in a battle that it has lost!
Used cars are the way to go!
Money Reasons’s Last blog..My Views On Robert Kiyosaki’s Financial Books
We’re just getting ready to start looking for a new car. After much thought, we are going after a well-rated Mazda model that’s already inexpensive, but we’re going to get a 2007 or 2008 for peanuts. On top of that, we’re going to experiment with buying from a car rental place, which is an even deeper discount.
Wojciech Kulicki´s last blog ..Get a Second Job and Quit Whining About Debt
Purchase New Car – You’re slumming here, there are no rich businessmen on this site. But your point is well taken.
Money Reasons – Excellent point about kids! My car is over 10 years old and I LOVE not having to worry about dings, dents and scratches. My son is a drummer who “leared his trade” on the passenger dashboard of the car, and it’s got the scars to prove it. Your kids come first, and you won’t be thinking that way with a new car.
Wojciech – We’ve been thinking about buying from a car rental place. I hope you’ll do a post on it and if you don’t please shoot me an email!
We’ve actually looked into this and the prices are good. The car rental companies are trying to get rid of them, and they’re usually less than a year old.
always use a checklist when looking for a used car. Each model is different.
best car is one you paid for, cash. No payments. I am loving my paid for truck right now.
Both are good deals but its totally depends on customer situation. If you learn driving a car so a used car would be preferable for you. But now a days new and used car deals both are available on very low rates.
Ford focus reviews´s last blog ..After Ford And Chrysler- It’s Mitsubishi Calling Back Trucks
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[...] cost is the reason for leasing, it will usually be better to either buy a good, late model used car, or a lower priced new car. Either way, once the car is paid off, you’ll have something to [...]