This may be the most important chapter in “The Financial Physician: How To Cure Your Money Problems and Boost Your Financial Health” Get your copy here.-Lou
WASTING MONEY ON A LIFETIME OF CARS
After our homes, cars are the costliest items that most of us buy. In the course of our lives, we will buy as many as 10 to 15 cars. So how we buy and finance our cars can make a huge difference in our financial health.
Years ago, most families had one car, which they kept until it died of old age. Today, families tend to have more than one car and will buy a new one every four or five years. And many people trade up more frequently.
The problem is that cars are both expensive and awful investments — in fact, they’re not really investments. They are de-investments, which is my term for assets that are guaranteed to decline in value. When you invest, you hope that the value of your investment will increase, but when you buy a car, you know that its value will steadily drop. Since the main purpose of a car is to provide transportation, to get you from point A to point B, it may be time to rethink how you purchase cars.
Cars are depreciating assets. Let’s say that you just bought an auto for $22,000. The salesman congratulated you for making such a great deal and as you drive home, you feel like a million bucks. Actually, you should be crying because you lost $4,400 the moment you left the lot.
New cars lose about 20% of their value as soon as you take ownership. Then they depreciate anywhere from 6% to 13% annually. So in the first year, you could lose $5,720 to $7,260. Ouch! The money you lost could have been saved or invested in assets that usually appreciate over time.
If you buy 10 cars during your life at an average cost of $25,000 each, you will lose $65,000 to $82,000 in first year depreciation alone.
Although the car manufacturers won’t like it, I’m going to make a bold, but true, statement: Unless you’re wealthy, never buy a new car. It will damage your financial health.
Buying a new car is a poor investment that guarantees buyers an immediate loss of wealth. A new auto is more expensive than a used car as are the monthly payments, costs of insurance and registration. New cars immediately depreciate at an accelerated rate so if you have to sell soon after you bought it, you’re going to take a bath.
Buying a used vehicle costs far less and makes much more financial sense.
Being financially healthy means accumulating wealth and we accumulate wealth by saving and investing. So let’s take a look at how much we really lose over a lifetime of buying new cars.
Lets assume that we buy 10 new cars during our lifetime — one every five years between ages 20 and 70. Let’s also say that the first year depreciation is $6,500 on each car. Had we invested that $6,500 and received an annual 5% return, at age 75 we would have accumulated $437,535, which isn’t chump change — if fact, it could be a nice retirement fund.
When you buy a new car, you also become exposed to a hidden danger that most people never consider, but that can cost them a lot. Let me explain.
When most Americans buy new cars, they put down as little money as they can and finance the rest. Usually, they finance 90% to 100%. So if you buy a car for $30,000, put down $3,000 and finance the rest, you would be obligated to pay $27,000 plus interest over the term of your loan.
If, a month or two later, you were in an accident and totaled the car, your insurance would only pay you $23,000, which would be the reasonable value of the car at that time. Since you owed slightly less than $27,000 on your loan, you would be out nearly $4,000 plus the initial $3,000 you put down and you would not have the car.
1. What to do
Buy a two or three year old vehicle that has just come off a lease. Over the years, the quality and reliability of cars have improved dramatically. Today’s cars are built well and can be expected to run for at least 150,000 to 200,000 miles when they’re properly maintained.
Many used cars, especially those less than four years old, have low mileage and look new. If you have them checked out mechanically, you won’t have to worry about buying someone else’s problem and you can expect years of safe, dependable service.
When you buy a used car, the original owner has absorbed the early depreciation. Instead of paying $25,000, you may pay $17,000, which is 32% less that the original owner paid. You also have to finance much less so your monthly payments, insurance and fees will be lower. If you decide to sell the car, you’ll get more of your money back because your car will have held more of its value. Over the course of your car-buying life, buying late-model used cars can save you lots of money.
When cars are returned to banks or finance companies at the end of leases, the lenders don’t want the cars. They want to sell them as quickly as possible to get their money back. So they work with dealers that specialize in selling off-lease vehicles for lenders.
These dealers are called lender liquidation dealers or liquidators. Every month, liquidators receive a large numbers of recently returned cars. The liquidator that I’ve bought cars from gets 1500 cars a month. It takes the best 250, put them in their showrooms and sells them to walk-ins. Then, they wholesale the rest at auto auctions. Since lenders are eager to sell, their liquidators frequently sell returned cars below book value.
Liquidators work with a number of banks and leasing companies and are paid a commission or a percentage of the sales price of the vehicles they sell. The balance of the sale proceeds they receive are turned over to the lenders.
My local liquidators’ showroom is filled with 150 to 200 cars so you always have a good selection from which to choose. They look new, have low mileage (most have between 10,000 and 30,000 miles), have been cleaned up and are certified as mechanically sound by the liquidator. Most cars are priced at three to five percent below book value. You can buy an extended warranty, finance your purchase through the liquidator or lease it or purchase it outright.
I’ve purchased six new-looking, dependable cars from a local liquidator. I bought each for less than book value and have always been well pleased. Buying from a liquidator involves little or no haggling because the cars are so well priced to begin with.
Check the Internet or your local phone book to find liquidators.
Before you buy a car from a liquidator, get the Vehicle Identification Number (VIN) and check its history. A number of online services provide reports on cars’ histories.
When you buy from a liquidator, the portion remaining on the vehicle’s new car warranty comes with your purchase. For example, if you buy a car that has a 50,000 mile or five year warranty that has been driven only 29,500 miles in two years, the new-car warranty will protect you for 20,500 miles or three years, whichever comes first. And if you wish, you can purchase an extended warranty from the liquidator.
The American Automobile Association (AAA) has a free program under which its members can get special prices on new and used cars. Under the program, members tell AAA which cars they want and AAA refers them to dealers that are participating in the program. The dealers’ have designated personnel who then work with the member.
2. What not to do
A. Don’t lease vehicles, new or used, unless you need to deduct the cost for business. Auto leasing is more expensive than purchasing because you don’t get equity in the car. Leases also include charges when you pile up heavy mileage. Initially, leasing usually costs less, but after you make your payments and return the car, you have nothing to show for it; you have no equity.
Cars are status symbols and ego boosters for many people, not just transportation. So they enter into short-term auto leases that are exceptionally expensive. In fact, leasing is the least cost effective method of acquiring cars. Avoid it!
B. Don’t buy used cars from new car dealers because you’ll probably pay more than if you went through a liquidator. Used cars are profit centers for new car dealers so they try to make a profit on every vehicle they sell. They usually won’t sell at or below book value, as will liquidators. I would only buy from a new car dealer if I couldn’t find a car I wanted at a liquidator.
C. Used car dealers may be the worst places to buy late model used cars. Used car dealers derive all their income from selling used cars, they charge the highest prices and the condition of their cars may not be reliable. Many used car dealers run small operations and are legendary for their questionable sales practices. At any time, they could close shop and leave you with little recourse if the car turns out to be a lemon.
D. Some owners know that dealers, new and used, will not give them fair prices so they try to sell their cars on their own. Many want to unload their cars because they have mechanical problems, which they won’t voluntarily disclose. If you buy a car from its owner and then have trouble, it may be impossible to get recourse from the owner. Only buy a used car from a private owner after you have had it thoroughly inspected by a qualified mechanic.