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: Library of Congress

I’ve always been confused by people who have perfectly practical luxury vehicles but choose to drive an older commuter car during the week. If you ask them about it, they say that they’re “keeping the miles off of it.” Exotic cars that have ridiculously expensive maintenance costs or are utterly impractical for regular use may be exceptions.  Then again, that’s not the point of buying a car like that.

Cars that are made in quantities of more than a few hundred are unlikely to become collector’s items, and therefore probably will continue to depreciate over time.  Mileage will make a difference in the resale value, but even still, that is more a function of time than mileage.

Keeping a second car around so that you can keep the miles off your car will also cost you some money, even if it is a total beater.  You still have to pay for the insurance, gas, tires, brakes, etc.  While these will be cheaper than the “weekend car,” these costs add up and would probably cost just as much as if you racked up a normal amount of mileage on a single car.  The bonus there is that you would be able to actually enjoy the car you bought more, and there would only be one car to maintain instead of two.

After all, presumably you bought the car to drive it, so what’s the point of keeping it in the garage all the time?  To me, it’s kind of like when people cover their nice couches and their remote controls in plastic so that they don’t get messed up.  At the end of the day, you’re sitting on some hard, slippery plastic instead of the nice plush sofa that you paid for.  In 10 years, it will be perfectly preserved, but that’s not really the point of a sofa – you bought it so that you could sit and relax on it.

The same thing goes for your Mercedes/Audi/BMW/Porsche/Corvette – get some use out of it, otherwise you will have paid for something very expensive without getting full use of it.

The flip side of this is that if owners like this didn’t exist, we wouldn’t be able to score great deals on barely used cars.  I used to drive over 25,000 miles per year, and my strategy has always been to buy a car with low miles (about half of what the average is for that make and model) and just pile on the miles for a few years.  By the time I’m done with the car, the mileage will still be considered low.  In some cases, it is roughly average, but I’ve thoroughly enjoyed it without worrying about mileage.

When the time comes to buy the next car, I’ll be looking for the one that’s been garaged and driven only on the sunniest, clearest days on the weekends.  I’ll pay a little bit of a premium on the front end of the purchase, but that’s  a small price to pay for enjoying the great cars I’ve been fortunate enough to own.  It’s also probably a smaller price than keeping a second car around for the sake of practicality.  To each his/her own, but for me, I’ll keep racking up the miles.

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 are shopping for a car or trying to decide whether to keep your car or move to a newer one, there is one simple concept that you must understand: total cost of ownership.

Total cost of ownership takes into account depreciation, operating costs, repairs, maintenance and insurance costs.  To make comparisons, you would calculate a cost per mile driven or cost per year of ownership.

Depreciation

I’ve already mentioned depreciation, and will continue to mention it because it is just so important to keep in mind.  This cost will be the single biggest contributor to the total cost of ownership if you are driving a relatively new model (within 5 years old or so). If you made the mistake of buying brand new, it will be an even larger contributor.

Operating Costs

Operating costs are things like fuel, tires, brakes, and oil changes.  These are wear items that are consumed on a day to day basis and make up a large chunk of your costs as well.  Fuel will be the biggest cost here.  If you drive a car that has different tire sizes on the rear compared to the front, you should break those costs out separately since they will wear at different rates.

Repairs

It’s hard to know how much repairs will cost you since they are by nature unpredictable, but you can get an idea based on how expensive the car itself is, its reliability rating, and by reading surveys from Consumer Reports.

Maintenance

Maintenance costs are predictable, since typically you know how much you drive in a given period, and that your car will require an oil change every 3,000 miles (or much longer if you are using a synthetic oil), your car gets a certain number of miles per gallon, etc.

Regular service inspections also fall under this category – these might be every 30,000 miles or so and cost in the neighborhood of $1,000 each, depending on what kind of car you are driving.

Insurance

Before moving to a different car, you definitely will want to know what the insurance will cost you.  You can find this out most often by requesting a free quote online from major insurance providers.

A recent study by Consumer Reports uses slightly different categories than I have just described, but the basic conclusion is the same: depreciation and fuel are the biggest costs during ownership, making up 46% and 26% of the total cost of ownership, respectively.

Source: Consumer Reports, 2008

Focusing on reducing depreciation, therefore, will lead to a huge savings over the course of your owning a car (Ramit Sethi would call this focusing on the Big Wins).  This is why, when gas prices were up around $5 last year (as they will undoubtedly be again in the future), selling your car to buy a brand new Prius just didn’t make sense since the depreciation hit outweighed the fuel cost savings.  We tend to focus on the costs that we see every day, such as gas prices and repair bills, but there often isn’t a lot we can do about them besides maybe driving less (and where’s the fun in that?).  Depreciation is the bigger worry here.

The moral of the story?  Buy used to save yourself from getting hit hard by depreciation, read this blog to learn more about how to buy the right car and keep its value as high as possible and stop worrying about fuel saving tips that will only make a 5% difference in your fuel costs (about 1% of the total cost of your car).

Here’s a spreadsheet I created to help you estimate your ownership costs and figure out what’s really costing you money. Yellow cells are for you to input, gray cells will be automatically populated.

Note: Insurance costs will expand or shrink based on how many miles you drive, so always update that with new information. The same with depreciation, but to a lesser extent since that is a function of both time and mileage. This worksheet is designed to illustrate the relative cost of different aspects of owning your vehicle, so if you’re an accountant and I have offended you by making approximations, count to 10 and stop hyperventilating.

Edmunds has a nifty tool called True Cost to Own that you should use when car shopping.

Depreciation isn’t a popular topic of conversation, because it just isn’t very sexy.  If you bring it up at a party, you will probably be rightfully ignored as being painfully boring.  Due to the fact that depreciation typically makes up more than half of the cost of a car over the course of ownership, however, it does deserve some attention.  So bear with me.

The biggest problem with buying new, besides the annoying and time-consuming task of dealing with car dealers, is that your car – one of the biggest expenses for most people – instantly loses thousands of dollars when you drive it home.   If you tried to sell your car with 50 miles on it on the used market, you would be at a loss of about 20% of the total purchase price.  This rapid decline in value is the depreciation of your car.

According to bankrate.com, a car typically loses 15% of its value each year.  This of course slows down over time, but the depreciation of the car after just a year of ownership can easily be 35% of the out-the-door cost once you take into account the taxes and fees.  That’s $8-9k gone from a car that cost $25,000 to begin with, which is nothing to sneeze at.

This sounds like bad news, but just the fact that you are aware of how much money can be lost in depreciation has armed you to become a much smarter consumer.  Even if you just buy a car that is one year old, you will have saved yourself thousands of dollars.  If you are shopping for luxury cars, the same rules apply, perhaps even moreso since luxury car buyers usually want to be the first on the block with the newest cars.  In the current economic climate, this is even more applicable, as people are trying to save money and buy fuel-efficient cars.

You can take advantage of this to buy cars which have been barely used at a huge discount.  It’s pretty difficult to tell the difference between a car that’s brand new and one that’s a year old, besides of course the much sought after new car smell.  Even then, buying a car from someone who is forced to sell because of a bad financial situation into a market with no demand might mean that you can land a car that even still smells new without suffering the big depreciation hit that the original owner did as he drove home.

A BMW 335i can be had for around $28,000 these days with the extended Certified Pre-Owned Warranty (6 years, 100,000 miles) to boot, if you are patient and negotiate well. One hell of a deal, if you ask me.