Let’s Talk About Car Buying

“Do the Math” Series

It’s time to buy a car. Or is it? Maybe you should lease a car. How much money should you borrow to finance a car and what are the best terms on a car loan? All good questions. To answer find our answers, we are going to take a look at some statistics about new cars and car buying in 2023. Then I’ll “do the math” with you to calculate what the best financial options are for purchasing a car. Buckle up. Here we go!

Average New Car Cost in 2023

Let’s start with some basic data. According to respected car guide Kelly Blue Book, in April 2023 the average new car price was $48,275. This means a lot of Americans are buying cars north of $50,000! That’s a lot of money. In fact, when you put that up against the average personal income in 2022 of $63,214 and the average household income of $87,864, how are people affording two cars much less one? That’s where car loans come into the picture. Bankrate tells us that the average new car loan monthly payment is $716. Here’s our first math: That’s $8,592 per year (per car!). Keep that number in mind for later.

Ok, what else do we know about new cars? You may have heard they go down in value the moment they leave the car lot. It’s a bit of a cruel joke, but it is true whether you are laughing or not. Cars can lose about 20% of their value the first year and roughly 15% a year for the next four years. Math calc #2. If you take the average new car price of $48,275 and slice 20% off of it, one year in your “new” car is worth $38,620. That is a drop of $9,655.

Losing Value Fast

Let’s put the picture in the frame here. Vehicles go down in value, so you paid just over $48,000 for something that is worth $38,600 a year later. Ouch! And you bought it on credit, so while it was dropping $804.58 of value per month, you were paying $716 for a depreciating asset (which is a fancy financial term for “something losing value”). Double ouch! Anything that loses value faster than you can pay for it is not an investment. Yes, a collector’s prized sports car might increase in value, but come on, the cars that people actually drive every day all decrease in value. Don’t be fooled by the pandemic and the crazy increase in used car prices for about a year. Thankfully, pandemics don’t come along every day to constrict the supply of new cars. You can trust that cars drop in value. It is a bad idea to finance something that loses value.

So back to your new car. You have had your car for one year and it is now worth 80% of what you paid for it. You’ll continue paying for your car for another 57 1/2 months on average. Yes, the average new car loan is 69.5 months. We’ll round down and say that making 69 payments of $716 means your payments will total $49,719.04. We know from Progressive that the average loan amount on a new car is $41,445 making the average down payment $6,830. When you add that down payment to your loan repayment, you spent $56,549.40 on a car that drops in value every year. Here is what the average car value looks like for the first four years:

Age of Car (Years)	Approximate Average Value
New	$48,275
1	$38,620
2	$32,827
3	$27,903
4	$23,718

That’s maddening! In four years that new car is worth half of what you paid for it. Because you chose to finance the car, you paid a premium above the value of the car that stretch across almost 6 years. Although it varies by car model, most people keep a car for 8.4 years giving you just about 2 1/2 years to drive with no car payment before taking on a car payment (a higher one, of course) again. That sounds like a bad dream to me. Every six years you pay $56,000 for a vehicle that keeps dropping in value.

Okay, a let’s take those numbers and have a little more math fun. If Average Joe does everything average, we will say he goes to college and has an average 42 year career. Assuming that the price of cars never goes up (ha!), our friend Joe will have bought 5.2 cars over this career and paid $306,759.20 for them.

That sounds terrible. So what alternatives are there to buying a car on credit? You can lease a car or pay cash. Let’s examine leasing a car first.

Leasing a Vehicle

Buying a new car is too expensive, so hey, why not just lease it? Put bluntly, leasing is the most expensive way to own a vehicle. There are a few reasons for this. Fees, new car depreciation, and more fees.

When you lease a car, you are paying for a few things up front. There are expenses that are common to buying and leasing like a down payment, taxes, title, license and registration, and often a documentation fee. There are also expenses that are unique to a lease agreement like an acquisition fee and rent fee. Rent charge is essentially the interest you pay rolled into the terms of the lease. Want to know the interest rate on your lease? Good luck. Dealers are not required by law to disclose the rate in the paperwork. There is also the depreciation and amortization payment. Remember how new cars have the largest drop in value in the first few years? Guess who pays for every penny of that in a lease? If you said “you” then you are a fantastic guesser. You pay the upfront costs AND the rent fees AND the depreciation.

But wait! There’s more!

No lease agreement would be complete without fees on the back end of the lease. Most lease agreements have a limit on the miles you can drive during the agreement, so if you live in Texas you might want to think twice about that annual road trip to see Aunt Susie in Washington. Exceeding the mileage means you get to pay the excessive wear fee which might be something like 25 cents per mile.

Math time!

If a lease agreement allows 36,000 miles over three years (which is pretty typical in a lease), anything over that amount turns every road into a toll road at $.25/mile. That limits your driving to 12,000 miles per year without extra charges. The Federal Highway Administration tells us that the average driver puts 13,476 miles on a car each year. If you hit that average exactly each year for three years you would drive your new leased car 40,428 miles before the end of the three-year lease. That’s 4,428 miles of excessive wear costing you another $1,107 in fees when you return the vehicle to the dealer.

And speaking of returning your vehicle, if you choose to return the leased vehicle at the end of the lease term you may pay a disposition fee for the dealer to clean and ready the car for resale. If you choose to keep the car, you have to pay the full residual value of the car, and you can bet the dealer was generous — in their favor — when setting the price. No haggling, take it or leave it.

One of your best wealth-building tools is your income, and one of the hidden costs of financing a car or leasing it is diverting your income from saving and investing to payments. The quicker you can make full use of your income by not having payments, the faster you build wealth. Having a perpetual lease or car payment will rob your retirement to pay for your depreciating car.

What options are left?

Paying Cash for a Vehicle

No one pays cash for a car! Well, that’s not true. Following a simple pattern, you can always pay cash for a vehicle, saving tens of thousands of dollars of interest payments over your lifetime. Here’s how it works:

1. Start with an affordable used car. Your first car should not be your dream car. Buy a reliable used car that you can afford. Used? Why? Let someone else pay for the steep depreciation for the first 2-4 years. Cars on the whole last longer than those made years ago, so finding a high mileage used car from high-quality car makers like Honda and Toyota will still give you plenty of miles to drive. Our example car that cost $48,275 new was only worth $23,718 four years later which is over 50% off that new car price tag. Dealers are going to mark that up to make a profit, but you can certainly find used Hondas and Toyota’s for less than $23,000 that you can drive for a decade or more after you buy it. If you don’t have the money to pay cash for your first car, either wait and save up or lower your expectations on the type of car you’ll buy. There is no such thing as a “forever car” so look in a price range you can afford. Your patience will pay off for you later.
2. Pay yourself a car payment. If you took out a loan for your car, pay it back quickly and then go to this step. If you didn’t need a loan, go directly to this step of paying yourself. Set up a monthly transfer from your checking account to a special high-yield savings account. That transfer should be the amount of a monthly car payment. Yes, you are paying a car payment to yourself in advance. Once you pay yourself year after year, you will have cash in your savings account earmarked for your next car purchase. This will allow you to buy your next car with cash.
3. Upgrade to your next car with cash. When you have enough money to pay cash for your next car, do. Use the cash to upgrade to a nicer car or use it to replace your car when the maintenance on your current car starts to exceed the value of your car.
4. Repeat. Now that you have your second car and have sold your first car, continue to pay yourself payments. Repeating this method creates a cycle where you never have to finance a car. This will save you tens of thousands of dollars over a 50-60 year span.

PRO TIP

There are two ways to pay your hand when buying a vehicle for cash:

Option 1 – The first approach is to research the value of the car including dealer cost so you know how much they will make on the sale of the car. Consumer Reports offers a service that will provide you that information for a fee. You can then contact multiple dealers and explain the exact vehicle you want and the price you are willing to pay. Give them a deadline to respond and then wait to see what happens. As long as you offer a reasonable price and build in some profit for the dealer, you stand a good chance of getting the car without the haggling.

Option 2 – Go to the dealer and follow the normal process, but don’t disclose that you will be paying cash until you have an agreement in writing on a price. Why? The dealer expects most customers to finance a vehicle, so they may be willing to accept a lower price up front assuming they will make money off the financing. This could secure a lower price for you. If they ask how you are paying for the car before settling on a price, just tell them that you don’t want to talk about payment until you agree on a price.

I have personally used the second approach, but I have seen both used successfully.

Summary

That wraps up this first in a series of Do The Math articles. To recap, cars drop in value, and you should avoid taking out a loan on anything that drops in value. Financing a car will tie up cash that you could be using to invest of build your retirement. Leasing is the most expensive way to drive a vehicle, so avoid it. Using a simple plan of paying yourself payments in advance will let you build a fund to buy a car for cash, saving you thousands of dollars in interest payments.

Armed with this knowledge, I wish you well as you look at buying your next car. For more insights like this or to up your personal financial game, consider working with a financial coach. To set up a free initial consultation, visit KJmoneycoach.com. I’ll be happy to show you how to Manage Your Dollars with Common Sense.