Question: “I’m thinking about buying a car. Mine is getting pretty old (or boring). What should I be thinking about as I approach this decision?“
This is a question we get from clients all the time. And for good reason. People tend to throw money away on cars. I’ll share the following points to help answer this question:
– Start With “Why?”
– Determine the True Cost To Own
– Set Your Budget
– Beware of The Mind Tricks
Start With “Why?”
It’s important to clarify what a car means to you. How important are cars to you? How do they rank on your life’s priority list? How do they jive with your values?
I drive a 2003 Avalon. For me, cars are a method of transportation to get from point A to point B. I’m not much into cars. There are plenty of other ways I’d rather spend money. But that’s just me. And I’ll admit that I occasionally get the itch to spend some money on a nicer car… but then all I have to do is take a peek at the numbers and the thought passes fairly quickly.
As you might expect, a car buying decision for me is 90% about the numbers and 10% about the experience. I’m probably going to make the decision based upon total lifetime costs and efficiency. There may be a speck of experience based decisions but it’s not going to drive the boat.
When you’re looking at cars, how do you value the material aspect versus the financial aspect? Clarifying your “why” behind buying a car will help you make much better decisions.
(For the Car Guy)
Now, if you’re a car guy, you should probably skip the true cost to own and set your budget first. Depending upon how much you’re into cars, there’s a chance those depreciation and all-in costs might not phase you. It’s better to have a budget set before you do anything that’s going to get you excited about buying a car. On the other hand, if you’re not a car guy (like me), the true cost to own should come first because you’re more likely to be impacted by the massive amount of depreciation and other costs that it reduces your budget.
Determine the True Cost To Own
Start by researching the cars you like on the internet (don’t go in person yet). Most people who buy cars don’t realize the all-in costs. Figure the true cost of ownership for different alternatives. This will help you make the decision on new vs. used. Edmunds has a great tool to help you research this.
For example, let’s say you like the Honda Accord. Take a look at the used car true cost of ownership and compare it to the new car.
For me, the depreciation costs (especially for new cars) totally kill my urge to buy. I find myself looking at older and older cars with more tolerable levels of depreciation. And then I compare it to my current car. And this then leads to my decision to keep my old car.
To give you an idea of how massive depreciation is, I’ll share some examples I found from the 5 yr cost calculator.
2016 Hyundai Genesis
Average Price – $55,077
First Year Depreciation – $16,303
2016 Chevy Impala
Average Price – $39,236
First Year Depreciation – $10,005
Although your payment on a new Chevy Impala might only be $600/mo, the depreciation alone costs $834/mo. When depreciation is higher than the amount you’re paying on the loan, you go underwater. When you’re underwater, the loan payoff is higher than the car value. Car dealers even have a product they sell to help you manage being underwater – it’s called Gap Insurance – but they should really call it “spending outside of your means insurance”… because that’s really what it is. But I guess that wouldn’t sell very well.
For fun, here are my projected #’s from my 2003 Avalon. I pull these out whenever I have the itch to buy a nicer car… and quickly realize it’s not worth it (for me).
Set Your Budget
It’s important to set your car budget before you get too serious. You’ll be better off buying cars in cash. Set a target for how much you can spend without depleting your emergency reserves. If your emergency cash target is $10K and you have $20K, your budget should be $10K. In most cases financing cars is a bad idea, especially if you tend to have trouble building cash reserves. The reason you’re having trouble building cash is because of past decisions like this. Time to put a stop to it.
If you have plenty of cash reserves and have the ability to buy the car in cash, then you might consider financing vs. using your cash (depending on interest rates, etc).
Beware of The Mind Tricks
Why is it that so many people with empty bank accounts drive nice cars?
Most people realize that they can’t afford the car they like. But they want it anyway. And it would be even better if they could get it AND convince themselves it was a good financial decision. So they immediately begin working to psychologically justify their poor decision. And financing is the perfect fix.
People typically use financing to justify buying something they cannot afford. They tell themselves… “well, the interest rate was so low – it would be unreasonable to pay in cash (assuming they had it).” After all, they could go invest and earn higher. They convince themselves it’s a smart decision. But it’s really just a sneaky mind trick people play on themselves without realizing it’s happening. As a result, they end up getting a car with a plummeting value and a payment they can’t afford.
And remember, this same person doesn’t have any cash reserves. That means they already spend what they make, and now they’ve added a car payment on top of that. This is moving in the wrong direction.
Financing is not the only justification. Sometimes it’s safety – that’s pretty tricky, too. Here’s how it goes…
“I need the safest car possible for my family. The 2017 Honda Odyssey is the safest car I can find that’s a good fit for us. So I’m going to buy it. Although I live month to month, I’m sure I can make the payments work for whatever reason I use to justify it even further.”
Then I might say something like…
“Well, what about the 2005 Honda Odyssey? It’s safety ratings are the same as the 2017. And you cannot afford the new Odyssey.”
And then they say…
“But I need a safe car for my family. A car that old isn’t reliable, which isn’t safe (stupid me for asking). And I can afford the new car. I just got a raise.”
I see very smart people do this all the time. I find myself doing it from time to time. It’s a mind trick we play on ourselves to justify spending above our means. And it’s dangerous.
Those with plenty of cash approach it differently. Although they aren’t totally immune to the mind tricks, it’s much less likely. They end up buying the car based on the money they have. Maybe they consider financing and compare it to keeping the cash. In most cases, they decide on paying in cash.
So the next time you’re approaching the car buying decision, take these steps to increase your chances of making the best decision possible:
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