November 06, 2017

Whether to buy a new or used car

Transportation is a cost. Whether you're taking a train, paying for a rideshare service, or buying a car, it costs money; and cars are a depreciating asset. As I've started planning my next car purchase, I've come across the stern advice that one should always buy a used car. The usual reason given is the immediate deprecation from just "driving off the lot." Let me put that in perspective and assert that used cars also have the same problem when driven off a dealer's lot, and then I will take a closer look at buying new cars versus used cars.

Driving a new (or used) car off the lot


Yes, the alleged monetary value of a new car will take an immediate hit after you drive it off the lot, or actually sooner when you sign the paperwork to buy it. But this essentially happens to used cars, too. Remember the three major methods of valuing a used car, from highest to lowest: (1) retail value, (2) private-party sale value, and (3) trade-in value. Retail price is irrelevant for valuing your car unless you are a dealer, of course (and there are other methods of valuation, like one used in bankruptcy court). So if you are buying a used car from a dealer, you are paying the retail value, but the highest amount for which you are going to be able to liquidate it is the lower private-party value. Essentially, your used car also loses value when you "drive it off the lot," too.

(I know a guy who bought a used vehicle from an individual, decided he didn't like it after a few weeks, then sold it for the exact same price to another individual. Lucky guy.)

So this is not a good argument against buying a new car. Just take a look at carmax.com or any website for used cars and see how darn expensive they are. Used cars have prices giving the dealers a profit margin, too.

Useful life of a vehicle


I think the most helpful way to look at the question of buying new versus used is to consider the useful life of a vehicle, weighed against some other factors. You should adjust your personal definition of "useful life" according to whether you prefer your vehicle to stay in like-new condition (requiring either cosmetic maintenance or buying a new car in a shorter timeframe) and whether your schedule is flexible enough for your car to spend much time in a shop. 

As for maintenance, the time required is a real issue for me. After I got tired of renting a car when my previous car was in the shop, I just went out and bought a newer car. (I eventually offered no-interest seller financing to sell my older car to a neighbor, after deciding that maintaining two cars was a hassle.) Maybe if you are retired and have two cars, it is no big deal and financially worthwhile to continue maintaining an older car. But if you are really busy and have more than one person depending on your car for their daily obligations, then it gets expensive to rent a car or take time away from work to let your car spend time in the shop.

So maybe your vehicle will last eight years before you don't want to fool with increased maintenance, or much less if you drive a lot for business. Or maybe you can handle the maintenance for fifteen years. You can divide the car's price by the number of years to determine your annual cost, and you can disregard the variance in year-by-year depreciation and the differences between retail price and other valuations.

Obviously, a used car will have a shorter useful life, so you are dividing a smaller number (price) by a smaller number (years) compared to the calculations for a new car. If the particular model of car is good at maintaining its resale value, then buying used is just as good (or better) as buying new. Whether the annual cost is smaller or larger depends on the rate of depreciation, which is probably a curve, and at which age you would buy the used car compared to the new one.

Risk


Risk of maintenance costs is another issue worth money. Yes, it might seem practical in the short term to shop for a much older car for only a few thousand dollars. But whereas some people think you should only buy used, others think you should only buy new because when you buy a used car, you are buying "someone else's problems." It might be worth paying a little extra to buy a new car that doesn't have defects.

However, since new cars can also have defects, I would guess that buying a newer used car (one or two years old) is actually the best way to reduce your risk. If a car had problems from the factory, then they might be addressed by the original owner or be revealed before the second sale, and this is before you have a lot of overall wear and tear bringing the later problems. If they were not addressed, then there might be mileage or time left on the original warranty. Unfortunately, though, some major problems only develop much later (but before 100,000 miles), so I am not really sure whether buying new or slightly used is better. 

Of course, if you are buying a ten-year-old car, then you can expect to immediately start spending a lot on maintenance, so I am not sure why spending less on an old car is supposedly such a good deal. Also, you should research the reliability of particular models to estimate at what age and mileage they might have issues. (In my experience, extra maintenance is needed for Nissans after 100,000 miles, for Chevrolets after 30,000 miles, and for Jeeps after 200 miles.)

Safety


From time to time there are major safety improvements that become standard in vehicles. Even if financially it might be worthwhile to maintain an older car, you might also consider whether it's valuable to start driving a car with newer safety features. For example, there were times when airbags and antilock brakes were not standard, and I remember when I wanted to buy a 2000 model car so I would have side airbags and not just front airbags. These days, a backup camera or a collision avoidance feature might actually save someone's life, so spending money to upgrade rather than maintain might be worth some money. (Airbags haven't saved my life yet. Lucky me.)

Financing


I bought a 2008 model car in 2010 with a five-year loan between five and six percent interest. I was smart for buying used, right? Except that dealers were offering some buyers financing at zero percent interest for new cars (with two more years of useful life), so I'm not sure that was so smart.

Let's say that for your situation a car has a useful life of ten years, and let's say that it will depreciate 25% in two years (which you cannot precisely predict but merely estimate based on that same model from five years ago (which could be a completely different car based on the manufacturer's redesign cycle, but whatever)). A new car for $30,000 with no interest on the loan would cost you $3,000 per year over ten years. A used car for $22,500 with a five-year, five-percent loan would cost you $25,500, and over eight years that's $3,187.50 per year. So with those assumptions, the new car is actually cheaper

Of course, I don't know if zero percent loans are offered anymore, but there is a point made on another blog that the cost of new cars can be brought down by dealer incentives that dealers of used cars don't have. And I don't know how much a particular car depreciates after two years, but you won't know either until two years in the future. The point here is that if you finance your car purchase then the higher interest rate just further reduces the savings of buying used.

Some people will say you should just buy a much older car for a few thousand dollars. But if I buy something really old for $2,000, then I'll probably quickly spend a thousand on maintenance, then get tired of that car with its problems, and then buy another old car the next year. If that cycle repeats, then I'm spending $3,000 a year on a car -- which was the cost of the brand-new car in the example above.

Conclusion


Driving is a car is always going to cost money, and there is a lot more to consider than prices and depreciation of car values. Prices are a starting point, but other considerations such as financing costs, maintenance costs, and safety needs affect the overall cost. Driving a car simply costs a lot of money, and even though deciding whether to buy new versus used seems like a big deal, all these considerations are just minor adjustments to the total amount you have to spend over the decades.

More reading

No comments: