November 15, 2016
“If you think nobody cares if you’re alive, try missing a couple of car payments.” Earl Wilson
First, if you live and work (or go to school) in an urban area with public transit, most people can get by without a car. Taking public transit is often inconvenient, sure. But it’ll save you a ton of cash compared to making car payments.
Now I’m not saying that everyone with access to public transit shouldn’t own a car.
The point I’m getting at is that if the only way you can afford to buy a car right now is by getting a car loan, and you have access to public transit for getting to work or school, there’s a good chance that you should not be buying that car.
I hope you’re not getting annoyed at me for saying that. Stick with me a minute or so longer.
Brent lives in Chicago and is debating whether or not to buy a car via a loan. If he buys a monthly public transit pass, it’ll cost him 100 bucks a month. But he feels that given his decent job and the fact that everyone else in his social circle has a car, he should have one too. He feels social pressure to conform. And besides, taking public transit to get to his job every day means a longer commute.
If he buys a brand new 2016 Honda Civic LX, it’ll cost him $19,670 by the time taxes and fees are added on.
His bank told him they’ll give him a car loan at 4% interest, to be paid off over 60 months (five years). His monthly payments will be $362. When the car is paid off, he’ll have paid the bank a total of $21,720, or $2050 more compared to paying cash.
Brent isn’t rich, so to him, having an extra $2050 would be a lot of money.
But wait, there’s more. Brent works downtown, so if he drives a car to work every day, he’ll have to pay $180 per month to park his vehicle there. He also has to insure his car. That will cost him close to $100 a month. And last, but not least, he’ll be responsible for maintenance and repairs. He’s budgeting low for this since it’s a brand new car under warranty – he figures $400/year is a good number (works out to $33 per month. He also budgets $200 per month for gas.
So the grand total cost of car ownership if he gets a loan to buy it comes out to $875/month (=$362 + $180 + $100 + $33 + $200).
Over the next five years, assuming all his estimates were accurate, he’ll spend $52,500 for the convenience of buying that car, using financing.
Now it’s time to consider how this new car purchase will look if he does it another way.
He can use public transit for a total of $100/month.
For this example, let’s say Brent could afford to pay $875 per month to own a car if he wanted to.
But let’s say he decides to suck it up and use public transit while he saves up the difference in cost to buy the car in cash. How long will it take?
Well, by taking public transit, he can set aside $775 per month (i.e. $875 cost of car ownership – $100 cost of using public transit). In only 26 months, he’ll have saved up $20150. Even if the cost of a new vehicle goes up by then, he’ll still only have to save for one or two more months, at most.
So let’s see how the numbers look now:
26 months of public transit at $100 per month adds up to $2600.
Buying the car with cash cost him $20,150. (For the purposes of this example, let’s assume that two years from now, a brand new Honda Civic LX would cost that amount, including all taxes and fees.)
Then we’ll tack on another 34 months of car ownership expenses, which would be about $17,442 (i.e. $180/mo parking fee + $100/mo insurance + $33/mo average repairs + $200/mo gas).
The grand total he’ll spend on transportation costs over the next 60 months (5 years) if he uses public transit for the first 26 months while he saves up to buy that car in cash is $40,192.
By choosing to save up and buy that car in cash, he’s putting an extra 12 thousand dollars in his pocket. (i.e. $52,500 – $40,192)
Just like that.
So what was the point of all that?
To show you how much money a person can save by using public transit while they save up cash to buy a car, and to show how quickly one can save up the cash to buy a car outright (even a brand new one!) if one makes strategic spending decisions.
Are you rich enough to burn 12 thousand bucks so that you can have a brand new car today?
And maybe you don’t want to buy a brand new car. Which is a good thing, actually. Because you can save more cash by buying a good quality used vehicle.
Let’s say our friend Brent from Chicago decides to buy a used Honda Civic that’s in excellent shape. He has to save up some cash first, and after 10 months of taking public transit he has $7750 saved up (i.e. $775 x 10 months). He finds a really nice used Honda Civic LX for sale with an asking price of $7750.
Because it’s not a brand new vehicle, he budgets more for repairs – about $1200/year, which works out to $100 per month if you average it out. He adds in $180/mo for parking downtown, $100/mo for insurance, and $200/mo for gas. The grand total works out to $580/mo.
So what does this add up to over five years?
Ten months of public transit costs him $1000.
The car cost him $7750 to buy.
And 50 months of driving the car cost him $29,000.
That all adds up to $37,750.
So in this scenario where he saves up for a quality used car, he’s putting an extra $14,750 in his pocket compared to buying a brand new Honda Civic LX today via a car loan for 100% of the cost. (i.e. $52,500 – $37,750).
Now obviously many of these numbers are best guesses. But the best guess is better than no guess at all and blindly signing up for a five-year car loan.
This is the kind of number crunching you need to do before you assume that you have to borrow money to purchase a vehicle. Look at the alternatives. Calculate the costs. See if the savings are worthwhile (usually, they are!)
Oh man, don’t get me started on leasing a car. Leasing a vehicle is often thought of as a more sophisticated way of owning one. And some people spout over-simplified nonsense such as “always rent or lease things that go down in value”. If you’ve ever heard that kind of crazy talk, this section of the book is for you. You’ll never again be left feeling unsure about leasing, wondering if you’re missing out by not doing it.
Let’s go back to Brent and that Honda Civic LX he wants.
The dealership tells him he can drive away a brand new Honda Civic LX for only $165/mo including tax. The lease term is 36 months (three years).
By the way, there’s also a one-time fee for title and licensing of $170, and a one-time document fee of $600.
Err, how about no.
In three years he’ll lease another new car, and for the sake of simplicity and our rough estimate, let’s pretend the fees and price remain the same. That means another one-time fee for title and licensing of $170, and a one-time document fee of $600.
The total cost of leasing for the next five years will be $11,440.
Don’t forget to tack on $180 per month for parking downtown for work, $100 a month for insurance, $33/mo for maintenance and repairs, plus $200/mo for gas. All that adds up to $513/mo, or $30780 over five years.
The grand total for leasing that vehicle is $42,220 (i.e. $11,440 + $30780)
Okay, so maybe now you think that doesn’t look too bad.
DON’T BE FOOLED. Car dealerships want you to think that. It’s all part of their master plan.
Now keep reading.
We already know that Scenario A, getting a loan to finance the purchase of a new car, is an expensive way to go, so I’m not even going to bother comparing leasing to that.
Instead, let’s compare leasing to the better options of Scenario B and C.
In Scenario B, Brent saves up the cash to buy a brand new car after using public transit for a couple of years.
The cost of his transportation for five years ends up being $40,192. So already, it’s cheaper than leasing, although not by a huge amount of money.
But since Civics are well-made and tend to be reliable, he figures he’ll keep this car for ten years, no problem.
For Scenario B, let’s add up the cost of his transportation for 10 years (which includes 26 months of public transit while he saves up the cash to buy the car, 60 months of low $33/mo repair costs because the car is under warranty, and 34 months of higher $100/mo repair costs after that).
For years 6-10 he’ll spend $10,800 ($180/mo) on parking downtown, $6000 ($100/mo) for insurance, and $12,000 ($200/mo) for gas. Car maintenance will cost him $4258 (i.e. 26 months at the new car warranty rate of $33/mo plus 34 months at the older car no warranty rate of $100/mo). All of that adds up to $33,058.
So if he saves up the cash to buy a brand new Honda Civic, and keeps it for ten years, he’ll pay a total of $73,250 for owning and operating that vehicle.
And, now this is important, he still owns the vehicle and could sell it for cash if he wanted. Say he sold it for $6500. Now his costs of transportation over the past 10 years drops to only $66,750 (i.e. $73,250 – $6500 profit from selling the car).
Whereas if he leases a new vehicle every three years, he’ll pay the fees that come with the start of a new lease three times in a 10 year period, for a total of $2310. And he’ll pay 10 years worth of monthly lease payments, totaling $19,800. And he’ll pay 10 years worth of parking fees, gas, insurance, plus maintenance and repairs (at the new car rate), for a total of $61,560.
That brings the cost of leasing a vehicle for ten years to about $83,670.
Leasing a Honda Civic for ten years would cost Brent about $17,000 more than he’d spend on transportation if he bought it brand new for cash.
And as you’ll remember, Brent would save even more money under Scenario C where he buys a high quality used Honda Civic for cash.
Repeat after me. “Leasing a car instead of buying a high-quality vehicle for cash will almost always cost more money in the long run.”
Never, ever, lease a vehicle unless you’ve taken the time to calculate the true costs, compared it to reasonable alternatives, and proven to yourself that it’ll save you money.
I came across an interesting discussion the other day where someone was arguing that any loan that has collateral is actually good debt, because you can pay it off anytime you want by selling the collateral used to obtain the loan in the first place.
This is such complete and utter nonsense that you should be recoiling from the very idea of it. Here’s why.
First, the value of the collateral could go down and leave you with a loan for more money than you can get from selling said collateral.
And second, if the loan isn’t making you more money than what you’re paying in interest, it’s basically causing you to flush your hard-earned money down a virtual toilet due to all the interest you’re paying to the bank (which you’d never have to pay if you’d bought the thing with cash in the first place).
You work hard for your money. Don’t flush it down a virtual toilet for no good reason.
Now you know enough not to be fooled by the lies you’ve been told about debt. It’s now time to sort out the good debt from the bad so you can prioritize what to pay off first. The next chapter will tell you how to do that.