How to (lose less money the next time you) buy a car

As a friend takes off his cap and gown and puts on a tie to head toward his new job, he’s ready for whatever life throws at him. Sure, he has student loans, but he saved so much money from not buying a house right away (thanks to the previous posting) that he deserves a little spoiling. Time to enter the next right-of-passage into adulthood, buying a car. He decides that the best bet is something with room to grow, that’s fuel efficient, and fast (we’re still young after all). He settles on a Ford Fusion (starting at around $20,000, but since the base model doesn’t come with air conditioning or seats, everyone buys the $25,000 model. He trades-in his $5000 college car and it’s time to “sign and drive.” The fine print said something about a 5% rate on $20,000 for 6 years. He ends up paying $322.10/mo. Not bad.

Meanwhile, a different friend decides to keep driving her $5000 college car just to see what happens. She is a little more conservative with money and tends to shy away from loans whenever possible.

Let’s drop in on these pals six years later to see how they’ve done. According to BankRate.com cars tend to depreciate 15% to 20% each year. Let’s err on caution and figure only 15%.

The first friend ended up paying all 72 monthly payments of $322.10 for a total of $23,191. Finally, the car is his. But it’s now six years and worth $7,542. Yes, he lost money. Lots of it. However, cars depreciate and it’s just a fact-of-life. But wait, there’s more. He also had to maintain full coverage insurance on the vehicle because he had a loan on it. This cost him an extra $50/mo. for all 72 months. Adding up all his losses, and remembering that he still has a sellable car, we find that he lost a total of $19,249 or $267.34/month. Just the cost of owning a car, right?

The other friend kept her $5,000 car. Nobody wants to drive an junky car so she drove it for three years before she decided to sell it for $3,070 and buy another $5000 car, which she drove another three years and could sell for another $3,070. She didn’t take out a loan so she could “self-insure,” that is, if she was in an accident and her car was totaled, she was only out the value of the car and had enough in the bank to replace it. She spent a total of $3,860 or $53.61/month over six years.

Wow. That’s a difference of $15,389 or 213.74/month! That’s quite a savings. But what if your friends kept this behavior up for their entire working life. They both started at 26 and would like to retire at the earliest possible date to receive Social Security, 62 years old. They will both be saving for 36 years. If your used car friend took the difference and invested it in a Roth IRA that invested in Growth Stock Mutual Funds that returned 10% per year for 36 years...that’s $1,020,536.95! She’s paying herself a million dollars simply to drive used cars. If she has a matching 401(k) or pension at work, her whole early retirement will covered!

(Caveat: Some readers may question whether this strategy will be suitable for them due to extra car maintenance needed for older used cars. First, don’t fall prey to the fallacy that new cars have no problems. Every year, J.D. Power and Associates ranks cars in initial quality (problems in the first 90 days). On average over all major models in 2011 they found 122 problems per 100 cars. Proving that even brand new cars aren’t free from repair costs. Secondly, this is a bit anecdotal, but I follow the “used car” plan and have kept track of my repairs. Besides routine maintenance like oil changes and tires, I’ve found my costs are around $40/month in repairs per vehicle. Even with such repairs considered you still have $829,558.32 after 36 years.)