Drive Virtually Free: Smart Used Car Buying Advice

Recently, a friend came to me for some advice on whether he should keep his current car or move to something new.  He has major car fever just like me, so his dilemma is a nice one to have: whether to stay with a Porsche Cayman S or move to a 2008 BMW M3.

Now, it is of course almost always less expensive to keep the car you have rather than move to another car if they are similar in class, age and price.  There are significant transaction costs associated with changing cars every few years – taxes, fees, transportation and time spent searching for the car.  Luckily, he is in a state where he doesn’t have to pay sales tax on car purchases, so the cost associated with frequently changing cars isn’t as high for him.

He wanted to know how much more it would cost him to switch to the M3, so that he could make an informed decision about whether it would be worth the extra cost or not.

If you can’t tell, I love spreadsheets.  So I decided to make a spreadsheet that breaks down all of the costs of keeping one’s current car versus moving to a different car.

I separated the variable costs from the fixed costs, so that I could see how the cost of ownership would change with the number of miles driven.  Some of the fixed costs aren’t purely fixed – your insurance and depreciation will depend on how many miles you drive per year, but since they won’t change that much within 5,000 miles higher or lower than average driving, I consider them to be fixed costs.  I included an opportunity cost in there because even if you are able to buy your car in cash, you are still losing the ability to invest the money that is tied up in the car.  If you finance your car, this takes the form of interest.

The variable costs are things that I have discussed before – maintenance, repairs and fuel.  I used actual costs for the Porsche in this example and estimated the costs on the BMW based on published numbers for fuel economy, my personal experience with the tire wear, and I was able to set many of the costs to $0 since they would be covered under the free maintenance program.

If I didn’t have this data, I could have used Edmunds’ True Cost to Own tool to make similar assumptions.  I had to use this for the depreciation figure as well.  Consumer Reports also offers this data with a paid subscription to their site, but sometimes data specific to high performance cars is not available.

After I had all of the assumptions plugged in, I summed up the costs in each section and was able to compare them.  The operating cost on the M3 is lower for the first few years because of their included maintenance program.  However, the depreciation, opportunity cost and tax and registration make the car more expensive to own over the next 1 year period.  In my friend’s case, he lives in a state that doesn’t have sales tax, so that item would be $0 as well and the two cars become similar in annual costs.

So, what did he decide?  He’s a car freak like me, and thought it was time to change despite the higher cost, so he’ll be shopping for a new car soon!

Photo: chuckbiscuito

A car’s ability to withstand a crash can mean the difference between life and death for its occupants.  Consumers do weigh safety into their decision to purchase a car – some more than others – but on the whole, I think it deserves more attention than it gets.  More to the point, I think there is an illusion of safety that has to do more with marketing than actual crash test safety data that needs to be debunked.

If you ask your average person which manufacturer they think makes the safest cars, more often than not they will say, “Volvo.”  Now, don’t get me wrong – Volvo makes very safe cars.  But if you look at the NHTSA (National Highway Traffic Safety Administration) ratings, so do most car companies these days.  Most cars built in 2009 have either 4 or 5 star crash test ratings across the board.

To give you an idea of what these ratings mean, here are the definitions of frontal crash test ratings from the NHTSA:

5 stars: 10% or less chance of serious injury

4 stars: 11-20% chance of serious injury

3 stars: 21-35% chance of serious injury

2 stars: 36-45% chance of serious injury

1 star: 46% or greater chance of serious injury

When you’re talking about serious injury, a 10-20% increase in risk is a big deal.  So, when you buy your next car, it’s worth the time to take a look at the safety ratings before making a decision.  Advances in airbag technology and stability control systems alone have helped make today’s cars safer than ever before, narrowing the gap between the safest cars and all the rest.  This is one reason I prefer to drive newer cars and purchase them used every few years, though it’s definitely not the main factor in that decision.

Tire pressure monitoring systems also help – keeping your tires inflated to the correct pressure will improve your car’s handling so that you will be better able to avoid accidents in emergency situations.  This also reduces the chance of  tire failure and can improve your gas mileage.  Most tire failures do not result in crashes, so this is less significant (the NHTSA attributes 400 fatalities (about 1%) annually to tire failures – not all of which result from underinflated tires).

You can find the NHTSA crash test ratings for different cars at www.safercar.gov.  Not all cars have been tested, but usually at least one car from a family of cars has been tested (e.g. they may have data for an Audi A4, but not the Audi S4).  The NHTSA also puts out an annual report on safety ratings for the current model year vehicles to enable buyers to make an informed decision as to how their short-list of cars stack up in terms of safety.

When you make your next purchase, take a look at the data rather than relying on the reputations of different car companies which have developed through anecdotal information and marketing.

Surely you’ve heard about the “Cash for Clunkers” program which subsidizes the purchase of new cars for those who get rid of their old, polluting gas guzzlers.  I won’t go into the details, but basically, if you purchase a new car that gets a certain number of miles per gallon more than your current car, you are entitled to a voucher worth $3,500 or $4,500, depending on the amount that your car’s fuel economy has improved.  This is basically another form of stimulus from the government to increase new car sales.

Smart is currently advertising a deal with $99/mo payments on a purchase of a Smart ForTwo for 36 months when you get rid of a vehicle which qualifies for the $4,500 “Cash for Clunkers” voucher.  Sounds great, right?  Well, wait until you read the fine print: there is a $6,667 balloon payment due at the end of the loan!

Subject to credit approval by the lender and the terms and requirements of the CARS Program and associated regulations promulgated by the United States Department of Transportation. $99.00 monthly payment based on customer trade-in of an eligible vehicle qualifying for the CARS $4,500 voucher level, a $70.57 combined contribution by Daimler Financial Services and smart USA, and a 36-month balloon loan with $0 cash due at signing and a final balloon payment of $6,667.50 at the end of the loan term and a $ 13,335 MSRP which includes the destination charge and excludes tax, title and dealer fees. 5.9% APR financing for 35 months at $11.30 per month, per $1,000 financed, plus the final balloon payment.

Now, to be fair, if you are able to use this incentive, financially it is not a bad deal at all for a new car (only because of the $4,500 voucher).  My gripe with this is not really about the cost, but about the way that it is advertised.  The $99/mo payments are advertised very prominently to get people in the door, and only when you’re about to sign off on the paperwork so that you can drive home will you find out about the big balloon payment.

This is, of course, similar to how we got into the “credit crunch” that we’re in right now – people getting lured in by initially low payments and getting hit with something they can’t afford a few years down the road in the form of higher interest rates.  Hopefully the finance people at Smart will keep this in mind and properly qualify their buyers.

The moral of the story is this: never, ever make a decision to buy based on monthly payments alone.  Always consider the entire deal – the sum total of the payments.  Never negotiate on monthly payments either, because car dealers will try and put you into more expensive cars with longer loans which still end up with lower monthly payments.  Or, they may try to give you a low monthly payment as long as you give them a big down payment, which still does not end up in a good deal.  Worse yet, they may stick you with a lease which has low payments, but costs you more in the overall scheme of things.

Going beyond just the terms of the loan, before you purchase a car, always focus on the total cost of ownership.  Make sure you have at least looked at what the depreciation, fuel economy, insurance, repairs, maintenance and interest are going to cost you, and that you can actually afford it.  Old supercars, for example, can be had for $20,000 to $30,000, but the fuel, maintenance and insurance costs will be a killer if you aren’t expecting them.  Don’t be caught off-guard.

This week, a friend of mine mentioned that he knew someone who had just picked up a new Porsche 911.  He said that he had leased it, and gotten a great deal – only $750 per month.  He has an allowance of $700 per month for his car as a benefit of his job, so he said that “it’s only  $50 out of pocket per month.”  That number seems very low, so since he leased new I’m going to assume he put a huge amount of money down.

I hear this all the time.  People claim that leasing is a cheaper way to drive newer cars every few years without worrying about the depreciation.  Do they think that car dealers are stupid enough to give away money by taking a car back for less than it’s worth without making them pay for it?

Let’s do a comparison of three scenarios: buying new, leasing new and buying slightly used (1 year old).  We’ll use the BMW 335 convertible as an example.

As you can see, the lease is not any cheaper because even though you have smaller monthly payments, you don’t actually own the car at the end of the lease and thus you cannot sell it. I assumed that the cars were identical, driven 12,000 miles per year, with a 5% annual interest rate. The depreciation data came from Edmunds’ True Cost to Own tool, and I assumed that there were no operating or repair costs since the car comes with a 4 year, 50,000 mile warranty and maintenance plan which is fully transferable. The lease is a special promotion going on right now, and is actually limited to 10,000 miles per year, but I decided to at least give leasing a fighting chance.

It may be true that a lease will insulate you somewhat against unforeseen depreciation, such as a gas-guzzling Cadillac Escalade with a lease ending in 2008, amid record high gas prices and a recession, both of which severely reduced the demand for big trucks and thus caused abnormally high depreciation. However, these cases are rare and, while I haven’t run the numbers, I would wager that it still would have been much cheaper to buy a slightly used car.

No matter how you slice it, car dealerships know how to make money and they wouldn’t push the lease option unless it were making them as much or more money. According to BMW, more than half of their customers choose to lease. Just as you should negotiate over total cost instead of monthly payments, you should look at the total cost of a lease rather than just the monthly payments relative to a purchase.

Now that we know that leasing is just about as expensive as buying new, if not more, keep in mind that there are all kinds of restrictions on a lease as well – they can ding you for going over your annual mileage, and anything they deem is “excess wear and tear.” If you decide you don’t like the car, you are often out of luck with a lease as well – you are committed to paying for the full lease, even if you change your mind after a month or so. (For more information on lease contracts, see the Lease Guide website).

No, thanks. I’d rather own the car and be able to do what I want with it.

To get more in-depth information on how to save thousands while driving newer cars, check out my e-book here.

When you’re trying to find the right car on the used market, searching only in a radius of a hundred miles or so might mean that you will be looking for a while before you find the car you really want. By searching across the country, you will improve your chances of finding the right car and getting a good value.

For instance, if you live in an area where everyone drives trucks but you are looking for a sports car, your selection is going to be pretty small. The same goes if you are in an area which is not densely populated.  If you are in an area which is densely populated, you can get a deal by looking at cars which are in remote areas where there is low demand.

Many of my friends and co-workers thought I was a little crazy when I said I was going to fly from Los Angeles to Ft. Worth, TX to buy a car, but it ended up being a great purchase. Since then, several friends have done the same with impressive results.

Here’s how I did it:

• I searched AutoTrader and Craigslist daily. To get a great value, you need to be the first or one of the first to call about a car.  You can set up an automated search on AutoTrader which will e-mail you new results daily, so you don’t have to spend much time at all on the search.
• I ran a CARFAX on the car. I saw that the price of the car was a few thousand dollars cheaper than comparable cars in the area, and had only 35,000 miles.  Once I saw this, I wanted to make sure it didn’t have a salvage, junk or rebuilt title.  Everything checked out, so I called the seller.
• I asked the seller a ton of questions over the phone. The seller was very open and forthcoming about the car over the phone.  I had prepared a list of dozens of questions at the outset of my car search, and had this document open on my computer when I called so that I could record his responses and take notes.  I got the feeling that he was very picky about his car, just as I am.  It seemed to be in almost perfect condition based on his responses.
• I found the best local BMW shop and arranged a pre-purchase inspection. The seller seemed like a great guy, but I couldn’t just take his word for it.  So, I went on a car forum which I frequent to ask the members in the D/FW area what the best shop was to get a pre-purchase inspection (PPI) done.  I called the shop to see if they offered a PPI service and to find out the price.  They quoted around $180.
• I went over the inspection report with the shop. I called the seller and set up a time that he could take the car in for an inspection.  I made the appointment with the BMW shop and made sure that they would fax me the report first and give me a call to walk through any problems.  It’s important to note that I found the shop myself and made sure that they understood that they were working for me, not the seller.  Otherwise, a dishonest seller could get a friend of his at a local shop to give the car a falsified clean bill of health.
• I offered to make a non-refundable deposit with the seller. I knew that the car was in high demand and the seller confirmed this when he told me later that I was the first of many out-of-state callers.  I offered to send him a few hundred dollars as a nonrefundable deposit just so that he would hold the car for me.  He kindly refused, and said that he would hold the car for me.  That made me a bit uneasy, but it worked out in the end.  Without a deposit, he had no reason to hold the car for me other than the fact that he was a nice guy and I was the first to call him.
• I scheduled my flight.  With limited time remaining, I scheduled a flight to Dallas using frequent flyer miles for myself and a friend.  Not everyone has the luxury of having frequent flyer miles, but if you don’t, this strategy is still workable if it’s the right car at the right price.  I set up my hotel stays with points as well, but I was staying in relatively cheap hotels as well.
• I headed out early. To make sure we were rested, my friend and I left work a little bit early on Friday and caught our flight to Dallas.  Flying in on the same day would have just been more hectic since there was a long drive home.
• I checked out the car.  The next morning, the seller picked us up at our hotel and I got a chance to thoroughly check the car out myself.  There were no surprises and the car was exactly as had been described in the PPI report, so we headed to his bank.
• I handed over my cashier’s check. I had drawn a cashier’s check prior to leaving home.  We went to the bank, where the title was being held (I made sure that he double and triple checked that they would have it ready to be transferred before I left).  We filled out a bill of sale, triple checking the information on it.
• I made copies of everything. I made copies of his driver’s license, the bill of sale, and any documents from the bank.  I wanted to be 100% sure that in the off chance that I was getting scammed after going through all these steps, I would have some sort of legal recourse.

After that, I was the proud new owner of a BMW M3!  My friend and I stopped at a local grocery store for some supplies and then began our mini road trip, returning on Sunday morning.

I took a similar trip from Seattle to Los Angeles along PCH when a friend bought a Porsche Cayman S using the same strategy.  Both cars have turned out to be excellent purchases.

It’s not for everyone, but there are cases where purchasing cars from across the country can pay off.  There are risks of course – the car could end up not being what the seller or mechanic described and you would end up having to come home empty-handed, and the seller could end up being a scam artist.  You also lose much of your negotiating leverage once you have left home.

To minimize these risks, learn as much about the car ahead of time as you can, before making a commitment.  Use vehicle history reports, pre-purchase inspections and phone calls with the seller to minimize the risk as much as possible.  In some cases, you might be able to have a friend or family member in the area check out the car as well.

If you don’t have frequent flyer miles and hotel points, here is a projection of what the costs might be:

• One-way airfare: $200
• Two night hotel stay : $200
• Airport parking (two days): $40
• Fuel cost (61 gallons at $3.00/gal): $183

Total cost: $623

I’m not a travel expert, so I’m sure there are ways to reduce those costs further, but you get the picture.  If the car is rare and/or undervalued or you are in a rush, this approach can work well for you.  Plus, you get a driving adventure out of it!