The decision to buy a brand new or “newer” used car isn’t always an easy one. There are many financial factors that should be considered before doing so. First of all, ask yourself, “Do I really need a new car?”
A CNBC article written in mid 2016 stated that the average car loan debt for Americans was at an all time record high, measuring at $30,000 per person, which is roughly $40,225 CAD at today’s currency exchange rate. That is a huge chunk of debt just dedicated to car loans.
It’s always ironic seeing car companies advertising that you only need “X dollars down towards your next investment! 0% down for the first year! Only $500 bi-weekly to own the vehicle of your dreams!” Well I wouldn’t call something that depreciates 30% as soon as you put 1 km or 5 minutes of usage on it an “investment”. With that said, it’s hard to justify borrowing money and paying interest on this borrowed money to finance something that depreciates instantly and continues to do so over the course of you owning the vehicle. Ultimately, it’s important to look at some key financial factors when deciding if it’s worthwhile to buy a new vehicle.
First off, determine the validity of the reason why you want a new car in the first place. Is my current car not reliable? Is the cost of owning my current vehicle too high? What better suits my needs for work? How often do I commute? What is my current financial situation? Try to find real justification for such a large purchase and don’t fall into the trap of wanting a new vehicle just for the sake of wanting something new or because your neighbor got a new car!
Secondly, determine the short term and long term affordability of purchasing a vehicle. Many individuals decide to finance or lease a vehicle. Depending on your living/work situation, leasing may be a better idea if you only require a vehicle for a short period of time. For longer term purchases, purchasing the vehicle outright is always the better idea over financing. If a vehicle is financed and a monthly payment plan is the only alternative to affordability, then why buy something you can’t afford in the first place? A home mortgage is different since home owners are typically landowners as well, who realize appreciation on both land and the physical “building” or unit. Long term debt on real estate is an investment. Long term debt on a Ford Ranger is not an investment.
The only exception to financing a vehicle is if a financing option is offered at 0% (which is not uncommon these days), which would require fixed monthly payments at zero percent interest. If you look at this alternative from a time value money perspective (i.e. $1 today is worth less than $1 tomorrow), then this may seem wise. In the end, you are just delaying payments of a severely depreciating asset over time instead of paying upfront the full amount. With a financing rate of 0%, this poses no cost of capital (cost of having debt) to you. However, there is some pride and literally “sense of ownership” having paid the vehicle in full right from the get go because you actually “own” the entire thing instead of the bank. Paying for a vehicle in full also forces one to plan their finances more strictly instead of planning around a monthly payment for the next 5 years and having a false sense of feeling “wealthier”.
Consider the graph below. Assuming a 2% financing rate over a 5 year term on a $30,000 vehicle with zero down, as well as an annual depreciation rate of 15%, by the time the vehicle is paid off, the difference between the cumulative total paid over the 5 years including interest and the actual vehicle's worth is huge (almost $18,000 in this example, which is roughly 60% of the initial price of the vehicle). An investment? I think not:
In addition to the pay in full/finance option, consider the following additional expenses of owning a vehicle:
-Gas: Average $50 a week
-Insurance: Average $120 a month
-Registration: Average $100 a year
-Maintenance: Average $400 a year
Based on these average estimates, this equates to an annual cost of approximately $4500 a year to own a vehicle, plus any depreciation. Obviously this depends on the type of vehicle and the usage frequency. Don’t forget new tires and rims if needed… that’s an extra $1000 easy.
Lastly, consider alternative modes of transportation that can offer options that may better suit one's financial needs and/or lifestyle. After doing the math, maybe a bicycle is a better alternative to a vehicle, or even walking for all my fellow downtown dwellers.
In the end, being open and realistic about the cost of owning a vehicle is important and will hopefully avoid any surprise costs that can (and will) come up in the future.