Part I - Economics of buying a Used Car

I bought my car last year in October after a couple of months research. And the views expressed in thisHappy Used Car article are solely mine that I developed while going through the process of buying my car. I had most of this article prepared by the time I got my car keys, but somehow it never made its way here.

For most of us, the family home is the biggest purchase we will ever make, and the car is often the second biggest, which are known as big ticket purchases. Not surprisingly, this is where the most money can be saved or wasted.

I believe in rational consumption decisions, and those who know me will not be surprised to learn that I have strong opinions on these issues. I believe that buying a new car is a big purchase but a bad investment. So let me explain why.


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2 important points to begin with:

1) Difference between big ticket and small ticket purchases:
By contrast, consumption decisions about items purchased frequently via simple transactions (e.g., cereal) are easier to make on a trial-and-error basis and can be easily improved. Because these decisions are routine and relatively inexpensive, they exert a much smaller influence on the life of the consumer.

2) Difference between buying a house and a car:
Unlike a house, the car is a depreciating asset, and is virtually a black hole for throwing money into.

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Advantages of buying a used car:

1] Finance:
The period during which one has highest capital available at his disposal is perhaps the first couple of years of starting a job life. This is the period when one is single, and most probably sharing his apartment with fellow roomies, thus being able to save a significant portion on his monthly rentals. Hence, if one goes for a used car he can save almost atleast half the amount he might be thinking of spending on a new car. This capital saved could have been put to better use in some wise investments. Furthermore, there are other hidden expenses that come along with buying a new car. New car mean higher insurance rates. In addition, a new car probably implies that a loan was taken since students who have just started their job life usually do not have strong credit history and hence they have to shell more mullah in paying higher loan interest rates. Also, the amount one has to pay for tax increases with the car's base price. Lets work out the finances by taking an example of a buying a new car vs a used car.

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(a) New Car :

Base Price = 20,000
Tax (5%) = 1,000
Insurance Premiums = more
Loan Interest (7% APR for 5 yrs) = 5,000
Total = 26,000+

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(b) Used Car :

Base Price = 10,000
Tax (5%) = 500
Insurance Premiums = less
Loan Interest (7% APR for 5 yrs) = 0 (since no loan was taken)
Total = 10,500+

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2] Flexibility:
The value of a new car depreciates much faster as compared to a used car. The moment you take your new car out of the showroom, its value depreciates by 20%. When coupled to the average yearly depreciation of 7% to 12%, your first year’s loss is anywhere from 25% to 35%. That translates to a first year $6,000 to $8,000 loss on a $22,500 new vehicle, or a $10,000 to $15,000 loss on a $40,000 one. And that’s for a vehicle only driven the average 13,500 miles. If you drive more than that, your depreciation will be greater (35% to 50% for the first year). Hence, you need to stick to your new car for atleast 3 minimum years before selling it off, if you need to get some decent value back. However, thats not the case with used cars. After the initial 3 to 4 year period, cars undergo a steady depreciation of around 10%. Therefore you are always free to sell off the used car that you bought as and when you feel like.

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3] More Value for same price:
It is so obvious but often underlooked. You can buy a used car with much more features than a new car with no features with the same amount. For example take a brand new 2007 Honda civic which costs around $15,000. Now thats a very basic model, the Honda Civic DX. With the same amount, one can easily get a used 2004 Honda Accord. Not only that but an EX V6 Honda Accord, with not more than 40K/50K miles on it.

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And now some myths that a lot of people believe in:

Myths:

1] Used cars carry high maintenace costs:
Its quite normal for one to have that feeling, but with Honda's , Toyota's around, one can safely assume zero maintenance costs. Japanese cars are very well known to be highly durable and efficient with their mileage. Their safety equipment is up to date, and comparable to new cars. Manufacturer's warranty is still in effect. Most new cars have 36 month general warranties, many have 48 months, and a few have 60 months all transferable to new owners. Many used car dealers certify almost-new used cars with comprehensive inspections and guarantees. Today, most modern cars are built to such high standards that second-hand no longer means second-rate.

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2] Driving a new car has its own experience:
I think its very subjective. But if you opt for a decent used car, say a 2004/2005 model which has been maintained well, you won't feel the difference. Furthermore even if there is such a thing as driving a new car, than I think it doesn't last too long beyong initial couple of months.

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Conclusion:
Cars are terrible investments. In their most basic form, they are merely a tool to get us from A to B. In their most elaborate form they can be a “shiny” tool that gets us from A to B, but with more luxuries. But either way, they are not likely to be much of a financial benefit. Add on maintenance, repairs, interest on the loan, and insurance and you can quickly see that automobiles can have quite a large negative effect on our finances.

I have always heard (and I agree) that a two year old car is a good age to buy, because you are still getting a fairly new car that is likely to have some amount of manufacturer warranty remaining, but yet a huge chunk of depreciation is knocked off.

By buying used, you let a car's first driver deal with that big depreciation nosedive. You get the car you want without the financial strain or the hassle of being several thousand dollars upside down on your loan.

And last but not the least, its more wise to go in for brands such as mazda or nissan who are as good as Honda's or Toyota's and whose resale values are not blown up as is the case with Honda's and Toyota's.