Drive Virtually Free: Smart Used Car Buying Advice

I realize I’m over a decade behind the times with this, but a friend recently recommended I read The Millionaire Next Door.  For those of you who don’t know anything about the book, it is an analysis of the habits of millionaires.  While my goal in life is not to save every penny so that I can die with millions in the bank, I do believe in saving on the big things, like cars – which is why I created this website.

Authors Stanley and Danko break their millionaires into four types of car buyers:

• Type 1: New Vehicle-Prone Dealer Loyalists (28.6 percent)
• Type 2: New Vehicle-Prone Dealer Shoppers (34.8 percent)
• Type 3: Used Vehicle-Prone Dealer Loyalists (17.1 percent)
• Type 4: Used Vehicle-Prone Shoppers (19.5 percent)

So, we can see that 63.4% buy new and 36.6% buy used.  To me, that seemed a bit off, since the theme of the book is that millionaires become as wealthy as they are by not wasting money, and buying new is not the cheapest way to buy a car.

The authors note that many of the millionaires who bought new cars and were loyal to certain dealers (type 1) did so for networking reasons – many millionaires are self-employed and believe in reciprocity to keep their business going.

Those in the second group, who shop dealers for new cars, did so to get a better price and because they seemingly enjoyed the negotiation and shopping process.

Those in the third group, who bought their used cars from the same dealers every time, did so because they had similar motivations to maintain reciprocity with their clients (this group contains the highest percentage of entrepreneurs) while also saving money by buying used.

The fourth group, used car buyers who are only looking for the best deal, are considered the “most aggressive bargain hunters” of those surveyed.  Their views on car buying would align with those I have written about most, since this is how I shop for cars.  This group is considered the most frugal of all, across all measures of frugality – not just car buying.  They know how to find a deal and are “in a semi-searching/buying state all the time.”

The authors mention that the fourth group is something special:

Of all the types studied, used vehicle-prone shopers are the most illuminating for those interested in studying the path to affluence.  Why?  Because of all the groups studied, its members have the highest ratio of net worth dollars for each dollar of income: For every one dollar used vehicle-prone shoppers realize in income, they have $17.2 of net worth.  They have the lowest average income of all the groups, yet, on average, they have been able to accumulate more than $3 million.

So, even though more than half of the millionaires in this study chose to buy new, I think the key takeaway is that a large percentage of the group still chose to buy used – and they’re millionaires! Also, those who bought new or from a dealer were aggressive in getting the price down either through using their business as leverage or by shopping across several dealers and making them compete.

What about vehicle purchasers in general?  Most vehicle buyers are not wealthy.  Thus, one might logically expect them to spend more time shopping for the best deal.  Our research shows the opposite.  Those who are not wealthy are less likely to shop, haggle and negotiate than those who are millionaires.  Car-buying behavior does indeed help explain why some people are wealthy while most are not and never will be.

So, there you go.  Even millionaires – especially millionaires – are aggressive about reducing the price of their cars.  Those with the lowest incomes in the survey became wealthy in part by buying used, negotiating and letting others take the depreciation hit over the first few years.

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.

Generally, I recommend staying away from car dealerships as much as possible.  After working in the #1 dealership on earth for a particular German luxury car, I know enough that it’s not worth the hassle and almost always ends up costing you more – particularly if you buy new.

With that said, there is one instance where buying from a car dealership can pay off, and that is by buying a Certified Pre-Owned car that is still quite new.  If you buy a Porsche, for instance, which has only been driven for a year and less than 10,000 miles (which is not uncommon) under the Certified Pre-Owned program, the warranty will extend to 6 years and 100,000 miles.  You can find a list of CPO warranty programs here.

To me, this is like having your cake and eating it too.  Since the car has already suffered its initial depreciation, you don’t have to worry about it shedding thousands of dollars in value on your drive home.  With the extended warranty, you don’t have to worry about getting stuck with an unreliable car, especially since it is backed by the manufacturer.

A car that has only been driven for a year or two with low mileage (preferably around 7,500 miles per year or less) will in all likelihood be indistinguishable from a brand new car.  You will also have the same amount of time to drive the car under warranty as someone who bought a new car.  The only difference will be that you can save somewhere in the neighborhood of 30-40% on such a car versus the brand new price.

Returning to the Porsche, Edmunds TMV puts the value of a 2006 Carrera 2S at $52,034 today (full dealer retail price).  Not bad for a car with a base price of around $80,000, especially with a warranty good for 3 more years.  Even if you can’t afford a Porsche, the same principle applies.  Your total cost of ownership will be drastically lower since the depreciation is not nearly as steep as buying new and you’ll still be fully covered by the manufacturer warranty which will prevent you getting stuck with big repair bills.

As long as you can deal with the high pressure salespeople in the dealership and keep your cool while negotiating, buying a relatively new CPO car is not a bad way to go.

Myth #1: Used Cars are Unreliable
Fact: Manufacturers improve the reliability of cars every year, and cars that are still reasonably new offer reliability very close to brand new cars.

Myth #2: Used Cars Don’t Have Warranties
Fact: If you target the right cars, you will also have the benefit of full factory warranty coverage. Newer used cars still have warranties, and there are many factory and extended warranties available if you should decide to keep the car for a longer period.

Myth #3: People Only Sell Cars When They’re Breaking Down
Fact: People sell their cars for all kinds of reasons – not just when they are on their way out. For many people, this is simply a matter of having the latest and greatest of everything as a status symbol. For others, the reasons include having children, relocating or needing to buy a different car to suit business needs.

Myth #4: Used cars are out of fashion.
Fact: First of all, think about how much fashion is worth to you. Are you willing to trade fashion for financial stability, or at least thousands of dollars in savings? Secondly, most of the time if you buy a car that is used, but still new enough to be covered by the factory warranty, you will still be driving the current generation of the car and hardly anybody will know the difference. The last generation BMW 3-series was a great example of this. It kept the same body style from 1999 to 2006, of which I have owned two. The only question I have been asked is how I was able to afford such a nice, new luxury car. The fact is, I wasn’t able to afford the cars new – I let someone else take on the depreciation and bought the cars for less than half price.

Buying a new car can be a remarkably fun experience for many people and is often a milestone on the path to being a “success” in life as well.

When the new car smell wears off, however, owners are often left with a frightening realization: that they have a new mountain of debt to pay off, and their car is rapidly declining in value.  In fact, a recent study found that this is the #1 regret of car buyers (granted, it was conducted on behalf of CarMax, who sell used cars). Sometimes, this reality doesn’t kick in for years when it comes time to trade the car in for a new one and the dealer offers a few thousand dollars as consolation. If you aren’t on top of your personal finances to find out where your money is going, it is very possible that this realization could slip by you for decades.

The fact is buying a new car just doesn’t have the same value that it used to. Modern cars are more reliable than ever, which means that worries of inheriting someone else’s nightmare should no longer hold you back from buying used.

If you’re still afraid of the downside, consider the huge upside, which is of course the cost savings. As soon as you drive a car off the lot, its value can drop by 20%. Add to that the 15% per year depreciation, and you are looking at an instant 35% discount by buying a car that is just one year old. On a $25,000 car, that means $8,750!

The car will still be covered by the full manufacturer warranty typically for another 2 to 4 years, so you don’t even need to be concerned about the reliability any more than you would with a brand new car. Once you factor in the additional interest and dealer fees, buying a brand new car and selling it after 3 years can easily be twice as expensive as buying a car that’s a year old, with no difference in styling, features, performance or reliability over the same 3 year period.

The next time you feel compelled to trade in a car for one that’s brand new, consider whether the new car smell is really worth the thousands of dollars that you’re giving up for it. Even in today’s economy, with huge dealer incentives and cash back, the used market typically offers better values since nobody is buying.