New Car Smell

Let’s look at some of the pluses and minuses of buying a new vehicle:

New Car Pluses

  • New car smell
  • No buyer’s remorse for at least a week
  • Looking super-cool

New Car Minuses

  • 10-35% first-year depreciation
  • Average 50%-plus depreciation after three years
  • Higher taxes and title
  • Much higher insurance costs, especially collision coverage

Financing a Rapidly Depreciating Asset

Suffering wicked depreciation and higher expenses across the board when buying a new car isn’t even the worst part. It’s the financing where they really get you.

Sometime after you finance that new automobile, the market value of your rapidly depreciating asset and your barely paid-off loan balance will meet. As your vehicle’s value continues to plummet from there, so does your ability to sell it. This is called being underwater on your loan. The higher the interest rate and longer the loan term, the faster and deeper you sink.

Don’t think you’re special because you can get one. Almost anyone can get a car loan. However, the worse your credit score and emptier your pockets the higher interest rate you pay. It doesn’t seem fair, but that’s the way it is.

In this example, nearly $24,000 extra in interest charges would be paid over the life of the loan. Even if you have a decent credit score and get a lower 12% rate, you’d still pay over $15,000 in interest.

I hope you see why I recommend paying off high-interest auto and credit card debt before investing. Erasing high-interest debt will no doubt earn you a better return on your money than investing it would.

How Much Should You Spend?

A mentor of mine long ago told me to never spend more than 10% of my yearly income on a car. I violated that edict once, much to my financial detriment, but otherwise, I’ve stuck to it. It’s saved me countless thousands. Sticking to 10% or even 15% enables you to save for a car and pay cash without bankrupting other more important financial goals like financial independence, real estate acquisition, education, and fun.

If cars are your thing and you want a newer car, buy last year’s model. You’ll still save on that wicked first-year depreciation and enjoy lower insurance, title, and taxes too. Even if it’s only slightly used with less than 5,000 miles on it, you’ll save thousands versus buying a new one.

Obviously, the older the car and the more miles, the less expensive the car. Remember that cars are built to last these days. A reliable piece of transportation can be had for just a few thousand dollars. From my perspective, there are so many better things to spend your money on than a new car.

How to Pay Cash

Even if you decide on a more economical mode of transportation, we’re still talking about thousands of dollars you’ll need for purchase, which you probably don’t have lying around. How can you purchase an automobile without financing? First, you need to be realistic as to what is affordable given your income.

Assume you have $20,000 budgeted for a new car. You clear $5,000 a month and can afford to set 10% of your net pay aside for an all-cash car purchase. It would take you 40 months to save $20,000, which is over three years. That’s way too long and expensive.

Now let’s apply my old mentor’s advice. 10% of $60,000 is $6,000. Now you’ve got your savings period down to just 12 months. A year’s worth of savings for your car makes more sense than 3-plus years, and you can buy a fine ride these days with that amount.

Existing Car Loans

What should you do if you’re already stuck with one of these wealth-sucking vehicle loans? If your new car smell hasn’t worn off yet, I’d sell it and cut your losses. That’s assuming the terms of your loan don’t make paying it off economically unfeasible.

Unfortunately, there’s a lot less regulation when it comes to car loans than mortgages, which means there are some frightful ones floating around out there. Hopefully, you don’t have one of them.

Does your loan have a pre-payment penalty? If you do, is it for the life of the loan or a shorter time frame? A prepayment penalty penalizes you for paying your loan off early, which is core to my debt-elimination strategy.

In the absence of a pre-payment penalty, is there a computed interest clause or other such verbiage committing you to pay all the loan interest originally owed? This despicable loan language lets you pay the loan off early, but you’re stuck paying all the interest originally computed per the amortization schedule. If you have one of these, you have my sympathies.

If you’re close to or are already underwater on your car loan, it’s best to pay the loan off as quickly as possible. If you don’t have a pre-payment penalty or computed interest clause, you can add extra money to your regular amortized payment and reduce your principal balance faster than the original amortization schedule called for. That reduces the amount of interest charged and shortens the time frame to pay it off.

Leasing a Car

Leasing can be the cheapest way to acquire a new car. Required down payments are usually lower for leases than for new car financing. That doesn’t mean you should go out and lease one. Remember the movie Groundhog Day with Bill Murray, where the same day kept repeating? New car leases are kind of like that.

It’s like the movie because by repeatedly leasing cars, you’re suffering the highest depreciation rates over and over, just as Bill Murray had to endure different episodes of the same day.

Vehicles lose much of their value during the first few years. When the lease expires, another new car is leased, and a similar steep loss is suffered once again. There are also lots of fees, of course, and they really sock it to you if you go over their maximum mileage allowance.

If you own your own business and use a car or truck exclusively for business purposes, that’s one of the few exceptions when leasing does make some sense. Besides impressing your clients with that spiffy new vehicle, you’re able to write off 100% of your lease payment to the business, which helps nullify some of those negatives.

If you simply must have a new car every few years, it’s going to cost you big time, whether you lease, purchase outright, or finance.

Ooh Ooh That Smell!

If you need even more incentive to avoid the new car smell, numerous studies have shown breathing the chemicals that account for the smell can lead to headaches, sore throats, and nausea. Longer-term exposure can cause problems that are much, much worse.

Chasing that new car smell is a skivvy, crooked racket that’s best avoided entirely. Please follow this “buy used, don’t finance philosophy.” You can easily save six figures over your lifetime when adding up all the saved depreciation, fees, and interest paid, plus your savings on insurance, title, and taxes.

There are few strategies that can save you this kind of money. Avoiding that new car smell could be a game-changer!

[Best Money Newsletter originally published 2023 0603 on the Strawberry Moon]