Here is one of the most important chapters in my book: “The Financial Physician: How to Cure Your Money Problems and Boost Your Financial Health” -Lou
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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.
FINANCING AUTO PURCHASES
When you buy a new or late model car, you can pay for it in a number of ways. If you have the money, you can pay cash; however, most people need to finance their purchases. Unfortunately, many buyers don’t think much about financing decisions, which can be just as important deciding what car to buy and how much to pay.
Never take a loan that runs for more than four years. Auto loans are like mortgages; the bulk of your payment initially goes to pay interest and then gradually decreases over the term of the loan. In the early years, you pay lots of interest, but not much principal. So if you try to sell the car in the first few years, you may not be able to get rid of it without writing a check because you owe more on your loan than your car is worth (remember our friend depreciation). Or you might have to use all or most of the proceeds to pay off your loan.
When an auto loan runs for more than four years, you probably will be paying too much for the car when you factor in all the interest and costs. Although longer-term loans have smaller monthly payments, bite the bullet so you can build more equity in your car more quickly.
Car salespeople will ask you what you can afford to pay each month because they can structure any loan to meet your needs. You can end up with a long-term loan that has smaller monthly payments, but your total outlay will be far more in the long run.
- If you can’t afford the payment on a four-year loan, don’t buy the car.
- Make a down payment of at least 20% to maintain some equity and not owe more on the car than its worth.
Here are the best ways to finance your car.
Zero or low interest financing
As I’ve stated, I feel strongly that people should never buy new cars because they cost them too much money. However, I’m realistic and know that people will buy new cars for a variety of personal reasons. If you must buy a new vehicle, try to finance it with a zero or low-interest loan.
Dealers offer zero and low-interest loans when the economy is slow and car sales are down. Even if you have the cash to buy the car outright, it makes good financial sense to take advantage of these dealer incentives because zero interest loan give you free money, which you can’t beat! So keep your cash in the bank and earn interest on it or invest it.
Most banks will arrange a car loan for you, and frequently give you better terms than dealer financing on both new and used car purchases. The interest rate they charge will be based on your credit rating. Before you shop for a car, investigate car loans. Check with a few banks and lenders. Find out the going rates and terms so you will know how much you can afford to spend for your car.
Interest rates make a difference. If you borrow $20,000 for five years at:
- 4% you will pay a total of $2,099.83 in interest.
- 8% you will pay a total of $4,331.67.
- Or a difference of $2,231.84.
Loans can be obtained through auto clubs and associations such as AAA. The financing that they provide usually comes from banks and other lenders. The auto clubs usually receive a small percentage of the loans they place so their rates can be higher than banks and direct lenders.
All dealers have arrangements with lending institutions to provide auto loans. Although dealer-arranged loans are convenient, they usually come at a higher cost. Car dealers frequently get a cut of the loans they place so you can usually do better with a bank.
Dealers may also pad the interest rates they quote you to increase their profits on car sales. Often, they won’t tell you what interest rate will be charged, but will only give you the dollar amount of your monthly payment. Dealers will try to entice you to take long-term loans, for as much as seven years, to lower the amount of your monthly payments and help get you into the car.
When some dealers explain financing and terms to you, they will overwhelm you with a flurry of words and numbers. Make sure that you understand everything they tell you, especially the loan’s terms! If all the terms are not clear, question them until you fully understand. If, after you ask a number of questions, you still don’t understand, get up and walk away.
Home equity loans
Although I believe in building equity in our homes and not taping into it for current needs, it may make sense to borrow on a home equity loan to buy a car. The interest rate on a home equity loan may be lower than those for traditional auto loans and they may allow you to make more flexible or extended payments. Most important, the interest on home equity loans is tax deductable in most cases.
TOP NEW CAR BUYING RULES
Most of us would rather go to the dentist than endure the torture of buying a car. Dealing with relentless, high-pressure salespeople is anything but fun plus it can be very expensive. When you deal with car salespeople, you constantly feel manipulated and know deep down that you’ll probably end up on the wrong end of the stick.
Everyone knows that car dealers have bags of tricks up their sleeves to maximize their proﬁts, but few know how to counter them. So most people dread going to car dealerships because they hate feeling that they will be overwhelmed, overmatched and coerced into paying far more than they should.
Car buying is an unfair experience. Two people can walk into the same car dealership, buy the identical car and pay different prices. And the difference can amount to thousands of dollars.
Unfortunately, woman and the elderly are most vulnerable to auto dealers’ tricks. Car salespeople know how to prey on them. Understanding the car-buying process and preparing well can help level the playing field and ensure that you strike a better deal.
The most important rule in buying a car is to be prepared BEFORE you walk into your friendly neighborhood car dealership. Do some homework up front, plan your attack and give yourself enough time to make the best deal.
Preparing to buy
1. What type of car you want to buy?
Identify your needs. Know beforehand what you’re looking for as specifically as you can.
Do you need automatic or manual transmission?
Do you need large cargo carrying capacity?
Do you want a sedan or SUV?
What gas mileage is acceptable?
List the safety features and options are important to you. ___________________________________________________________________________________________________________________________________________________________________________________________________
2. How much can you afford?
Get a copy of your credit report and FICO score at www.annualcreditreport.com. Download your credit report and print out a copy. You can get one free each year.
Your credit score will determine the interest rate you will have to pay on an auto loan. Visit your bank to see what terms it will give you on a car loan. Also research the terms car dealers, auto clubs and other lenders are offering.
Assume you will be financing a maximum 80% of the purchase price and find out the terms on 48-month loans.
A family’s monthly car payments should not exceed 20% of its monthly take home pay. At www.edmunds.com you can find financial calculators to help you estimate your monthly payment. That payment will be based on the purchase price, down payment, interest rate and length of loan. Print or write out the figures and bring with you when you shop for a car.
3. Consider all ownership costs
Inquire into the cost of insurance for each vehicle you are considering since those costs can vary greatly. Insurance costs are linked to car safety, which is information you should know and use as bargaining points with car salespersons.
Also consider depreciation; a car that may be less expensive than another car could depreciate at a faster rate, which would make it more expensive in the long run. Factor in each car’s gas mileage, service program, warranty and repair costs when determining the car’s long-term cost.
4. Determine your car’s value
Before you buy a new car, find out your present car’s fair market value at www.kbb.com, www.edmunds.com or www.nadaguides.com. Then try to sell it privately because you usually can get a better price than if you trade it in. Here’s what to do:
- Place an ad on Craigslist, www.craigslist.com or in your local newspaper or advertiser
- Accept payment only in cash or by certified check or you could get burned
- Immediately after the sale, file any required papers with the state so if the car is then involved in an accident, you won’t be legally liable.
5. Trading in your car
Again, determine your car’s fair market value. Expect to be lowballed. New car dealers will try to give you as little as possible for your car because they plan to resell it and the less they pay, the more they make. They will find problems with parts that you never knew existed.
Although dealers won’t offer you the full value for your car, the fact that you know your car’s actual value can help you negotiate a better price. However, don’t expect to get as much as you would by selling your car on your own.
Negotiate the price of the new car first, and then discuss your trade in. Since you’re there to buy a new car, focus on it and don’t let the salesperson divert you by starting negotiations on your trade in.
6. Go online and do research
The Internet is loaded with lots of great information on buying cars. Dealers have created Internet sites that allow car buyers to shop online. If you go online, you can check dealers’ inventories, search the options available and find out how much cars costs. Also look into dealer incentives such as rebates and zero-percent ﬁnancing. When you narrow down the vehicles you’re interested in, go to dealer for a test drive and negotiate a deal.
7. Get dealer invoice price
Learn how much the dealer paid for the car before you negotiate. Forget about the sticker price or Manufacturer’s Suggested Retail Price (MSRP); it’s primarily for show. What really counts is how much the dealer has invested in the car.
To find the dealer’s cost, go to www.edmunds.com and download dealer invoice prices. In most cases, a dealer will accept $500 to $1,000 over its invoice price. On popular models, you may have to pay closer to the sticker price. Since these models are in demand, dealers don’t have to discount them.
Learn all additional costs that you will have to pay. They include taxes, registration and destination charges. Make sure that you need or want what dealer is trying to sell you. If the dealer claims that something you don’t want comes with the car, insist that the dealer to take it off. Don’t pay for delivery, handling, ﬂoor charges or any other unnecessary charges the dealer tries to bill you for.
8. Don’t say how much you are willing to spend per month
Oldest trick in the book and one of the ﬁrst questions a salesperson will ask is how much you can afford to pay each month. Even though you already determined that before you went to the dealer (see #2), don’t answer. If you do, it will give the salesperson the upper hand because he or she can structure a loan to both fit within your figure and get his or her price for the car. Always negotiate the sales price on the vehicle itself — never on the monthly payment amount!
9. Play it cool
When you find the perfect car, don’t gush or show your excitement. Play it cool because when salespeople sense that you’re head over heels about a car, they move in for the kill and it becomes much tougher to negotiate a great deal. Take time to look at the deal more objectively. Ask yourself:
- Is it the right car for me?
- Does it have everything I want or is it loaded with too much?
- Am I prepared to take on the expenditures necessary to buy this car?
10. Go home and cool down
Dealers count on buyers acting impulsively. They know that people fall in love with cars and will go for terrible deals. Once you give them a glimmer of hope, they will push you to close the deal.
When you think that the sales person has offered you the best deal and you are ready to buy, let time work for you. Tell him or her that if you buy the car, you will buy it from him or her, but you need a little time to digest all of the information you receive and think about it.
The salesman will do everything possible to convince you to buy now (especially if it’s the end of the month), including saying that the deal is only good for that day. Believe me, if you come back three days later, he or she will make the same deal.
After you leave the showroom, some salespeople will phone you relentlessly to convince you to close the deal. So think twice before you give them your phone number.
Take time to reflect on the deal, to make sure it’s the car you want and that you can afford it. Be certain that you understand your total costs and that you got the best ﬁnancing available. When you feel comfortable with your decision, go in and buy the car.
11. Beware the business manager
After you agree on a deal with the salesperson, he or she will escort you to the business manager’s office. As he or she completes the paperwork, he or she will try to squeeze more money out of you by attempting to sell you dealer add-ons such as rust-prevention undercoating, sealants, auto-theft-recovery systems, insurance and extended warranties.
These extras are expensive and their costs can mount up. Usually, they are unnecessary so say no thanks and complete the deal. The manager or salesperson may press you, but stand firm because they usually won’t risk losing the deal.
Leasing allows many people to buy cars they otherwise couldn’t afford. When they lease a car, they actually rent the right to use it for a period of time, such as 36 month, 48 months and so on.
Monthly lease payments consist of two components: depreciation and interest. Since those who lease never own the car, they pay only for the portion of the car’s value during the lease period.
Leasing has some short-term advantages over buying. They are:
- The amount you have to initially put down to lease a car is usually less than what you put down if you bought it.
- The monthly payments are lower than if you bought the same car and financed it with an auto loan.
- Leasing expensive, luxury cars for business can provide tax advantages. When you lease a car, the interest is rolled into the monthly payment making it tax deductible. In contrast, interest paid on car loans is not tax deductible.
- After the lease expires, the car can be turned in and you can lease a new car, which works excellently for those who want to have a new car every few years.
Financially, the disadvantages of leasing far outweigh the advantages.
- You never build equity in your vehicle because you never actually own it. You only have the right to use it.
- You always have car payments. If you buy a car and the loan term expires, your payments stop. Since cars are now manufactured to run dependably for as much as 200,000 miles, you can own a car for a long time after you have stopped making payments.
- If you exceed the maximum allowed mileage on a lease, you have to pay an overage charge when the lease is up. If you drive a lot and put on excess miles, you can be hit for a hefty payment.
- It’s hard to terminate a lease early. Penalties are involved and all the charges can be costly.
- When your lease is up, you can be charged for wear and tear, which can be significant.
- If you decide to buy the car when the lease is up, it can be very expensive. You might have to get a loan to finance your purchase.
- Leasing contracts are very confusing. Often, you have no idea how much you’re actually paying to lease the car.
- In the long run, leasing is more expensive then buying a car.