Just recently I was faced with the ultimate financial decision: Buying a new car.
The intrigue and feeling of buying a brand new car is very exciting. However, after the new car smell is gone and you have made four to five auto payments, the excitement starts to wears off.
In fact, in some cases, some people are left asking, “Did I just make a financial mistake?”
With 121,000 miles on a car valued at $2,000 yet needing $3,000 worth of repairs, our decision was clear; we needed a new vehicle. But we didn't know where to start.
So we decided to reach out to a trusted financial advisor about potentially getting a brand new car. His advice was an emphatic two-letter word:
He repeated again, “No, never buy brand new cars.”
Which is why I decided to write about the reasons to never buy brand new cars. But first, it's vital to understand:
Never buy brand new cars ….only buy used cars!
After housing expenses, transportation expenses are second when it comes to monthly budgets.
From auto payments to insurance, gas to maintenance, cars will cost the average American approximately $9,000 a year on average.
While some aspects of transportation expenses are not as controllable, expenses like:
- Commute length,
- Insurance and
- Necessary car maintenance
The one automobile expense that is controllable is your monthly car payment!
Ultimately, the buyer (you) decides to take on monthly car payments and what size those payments are. So if the average adult is spending nearly as much on their car every year as they are on their home, here is a financial nugget:
Cars are a financial liability, so always buy used cars, never brand new!
In most cases, a brand new car will cost somewhere around $6,000 annually depending on the type. Yet, that same new car will depreciate so fast that in five years when it is finally paid off, the same car will only be worth 37% of the initial purchase price.
However, if you buy used, you save money in the long run…!
7 Reasons You Should Never Buy New Cars
We buy things we don't need with money we don't have to impress people we don't like.”
Car payments are often viewed as a necessity. On average, Americans drive more than any country and it is estimated you will spend 4.3 years of your life driving.
Just because most scenarios require car ownership doesn’t mean it has to be a huge monthly expense.
1. Cars depreciate at a rate of 20% a year.
A brand new car depreciates at a rate of 20% per year on average. In fact, the second you drive it off the lot, it has already depreciated 11%.
That is like saying you bought a laptop at BestBuy for $1,000 and when you decided to return it the next day and they say it is only worth $890.
Imagine if all things depreciated as fast as a car – Your $300,000 home is worth $277,000 the day after you moved in. At the end of the first year of homeownership, your home is worth $240,000.
Most would be freaking out if they knew their house lost 20% of its value in one year. However, the same can not be said for car ownership.
2. Your debt to income ratio.
A new car can greatly hinder your debt to income ratio.
If you have never heard of your debt to income ratio, chances are you will when you go to buy your first home.
Your debt to income ratio refers to the amount of money you pay each month towards debt in monthly payments, compared to your gross income.
To figure your debt to income ratio out, add up all monthly debts payments (auto, student loans, credit card, mortgage, personal loans) and divide that number by your gross income.
However, what buying a brand new car can do is greatly hinder your debt to income ratio!
Why is your debt to income ratio important?
If your debt to income ratio is higher than 43% you are going to have a tough time getting a qualified mortgage when you go to purchase a home.
Hence why in my 6 things college graduates should know about money post, I tell recent graduates to never buy a new car or it will compromise your DTI.
Or as mortgage loan consultant Brian Scott put it,
“Buying a new car can potentially keep you from qualifying.”
One of the quickest ways to screw up your debt to income ratio is to purchase an automobile with a huge monthly payment.
One of the quickest ways to lower your debt to income ratio? Have no car payment. Here is a link to find your Debt to Income Calculator.
3. Cash is King.
The average person with a car payment will spend $479 per month or roughly $6,000 annually on their car payment
$6,000 is a large amount of money that could be going to something that pays you, instead of something that depreciates!
By not having a huge monthly auto expense you can throw more into savings, paying off debt (like student loans), or into retirement.
A common financial expert tip you might hear:
Never leave money on the table. If your work matches 100% of your 401K contributions, then that is a 100% return on your investment.
Similar to the statement above, never take money off the table with a brand new car purchase. The monthly car payment sabotages your cash flow. Having more freed up cash in your monthly budget gives you options.
Financial security is all about options. Our household vehicle costs are a combined $320 a month – fuel & insurance – which is only about 4% of our monthly budget.
Cash flow is more important than driving a brand new vehicle. There are better options than buying a new car like refinancing a car or downsizing. Always explore those first!
4. A new car is NOT an investment.
Contrary to what many think and are told from a young age, a car is actually not an investment.
Sure a paid-off car does count in the asset column according to the IRS, but other than that cars are not really true assets.
Read any book about finances and people with strong financial portfolios do not view their cars as assets. They view them as liabilities. The experts view cars as a necessity to get them from point A to point B.
Why is a car a liability you might ask?
For starters, the depreciation factor. An asset produces and grows (think investments), it does not depreciate. A liability decreases in value, such as a car. Vehicle owners should also expect to budget $99 a month for yearly car maintenance and tires.
Related: Steps to Buy A Car The Right Way
5. Car companies want you to have payments.
A simple trick to all personal finance situations:
Think the opposite of what you're being told.
The laptop warranty “You really need to have” is a warranty you probably don't need. Using the same logic, car companies use car payments to help buyers think they can “Afford new cars.”
By getting you to focus on monthly payments that have been stretched out to 60 and 72-month loan terms, they can get them to a point where you can afford that new car.
But do the math – making a car payment for 5-6 years is a long time. And remember, by year five your car is worth 60% less than the purchase price!
6. Used cars are simply more affordable (By about 40%+)!
When you buy a certified preowned car you're not only walking away with an almost brand new car, you're saving close to 50%!
Most lease terms for cars last 24-36 months which means a few things:
- Leased cars have low miles
- Routine maintenance is almost always performed
- They are generally low mileage, but like new!
So when you go to buy a used car, you're getting a steal and you let the previous owner or lease eat the 40% depreciation if you buy two years used!
Personal Note: When we decided to buy a used 2016 Altima, the original purchase price was $27,000. We spend less than half, even with taxes and tags!
7. You'll overspend with your new car purchase!
Perhaps the biggest issue with buying brand new cars is the fact that most people don't really understand what a good price is for a brand new car.
Car companies will use sales tactics like leasing cars and long loan terms to get customers to buy new cars – even if they can't really afford it. While buying a house means you use a budget and get preapproved, in most cases buying a car isn't so stringent.
In order to prevent overspending on a car, new or used, always follow this rule when it comes to car buying:
25% Gross Income Car Buying Rule
When buying a car, to make sure it is within your budget, be sure to follow these steps:
- Take your gross income and divide by four to figure out 25% of your gross income
- Buy a car that's value is no more than 25% of your gross income
For example, if you make $50,000 per year, your car's value should be no more than $12,500.
In most cases, this means you're looking in the used car lot!
When should you buy a used car?
Most will financial experts would recommend buying used vehicles around the two-year mark.
By buying pre-owned you wind up saving 40%, you can still get a nice car and cut your payments in half. If you manage to catch a Labor Day deal, you get to save even more – see Edmunds, KBB, Find the Best Car Price. A simple way to guide you in buying your car is this:
As a general rule of thumb, your car should never cost more than half of your net annual income!
For example, if you take home $40,000 a year a vehicle that costs $20,000 is way too expensive.
Other items to consider when buying a car are the cost associated with:
- Maintenance costs,
- Annual fuel expenses,
- Insurance costs, and
- Personal property taxes.
Sometimes a car payment is, in fact, manageable. However, when coupled with all the other associated expenses, it can become unmanageable and impact your savings rate!
Every time I see this on Facebook I want to scream,
Just purchased my dream car, hard work really does pay off!”
Or in my case, I simply said “New Whip,” which as you can see in the photo below that I posted on October 3rd, 2014…
The only thing worse than the statement above is the 136 likes and 23 comments all saying things like, “Awesome job,” and “Keep up the hard work!”
Keep up the hard work was what I had to do in order to afford my brand new truck I should have never bought. I found myself constantly doing odd jobs and counting pennies just to not feel stressed about my $400+ truck payment.
Not to mention, going from no auto payments monthly to now paying for a truck, taxes, more fuel, and more insurance was costing me close to $800 a month!
I quickly came to my senses and nine months into my truck ownership I quickly got rid of it and settled for a used sedan. David Bach, a self-made millionaire, and financial author has been quoted saying,
“Buying a brand new car is the single worst financial mistake you can make.”David Bach
So the best piece of advice I can give you when it comes to buying cars is to buy used. Do things differently now, so you can live like no one else later!
Q: Do you think buying new is a good or bad idea?
Josh writes about ways to make money, pay off debt, and improve yourself. After paying off $200,000 in student loans with his wife in less than four years, Josh started Money Life Wax and has been featured on Forbes, Business Insider, Huffington Post and more! In addition to being a life-long entrepreneur, Josh and his wife enjoy spending time with their chocolate lab named Morgan, working out, helping others with their debt and recommend using Personal Capital to track your finances.