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!

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.

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.