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 drop in value from the moment you drive them off the dealer lot.”
Most of us know this to be true, 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, and there are great websites that can help you find a huge inventory of used cars where ever you live.
- 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?