Never buy a new car.
Transportation expenses are second behind housing expenses when it comes to monthly outgo. From auto payments to insurance, gas to maintenance, cars will cost the average American approximately $9,000 a year.
Some of that is not controllable – commute length, fuel, insurance and necessary maintenance. But one automobile cost is 100% controllable – monthly car payments.
So if the average adult is spending nearly as much on their car every year as they are on their home, why don’t more people question automobile expenses?
Every time I see this on Facebook I want to scream:
“Just purchased my dream car, hard work really does pay off”
The only thing worse then that statement – the 136 likes and 23 comments all saying awesome job, congratulations, and keep up the hard work!
What most don’t understand – they just purchased a liability that will cost them somewhere around $6,000 annually and will depreciate so fast that in 5 years when it is finally paid off the same car will only be worth 37% of the initial purchase price.
I can make this (bold but truthful) statement because this was 100% me almost 4 years ago (My big truck article). Purchasing a brand new truck and trading in my paid off car jumped my monthly auto expenses $500 monthly and over $6,000 annually.
There it is, 113 likes and 17 comments about my brand new truck that I had no clue would set my finances back big time.
At first it did not seem like a lot, but when it came time to pay bills I realized I was completely over-leveraged. I snicker at the fact that lenders actually let me put myself so close to the line, all because I had “good credit”.
Luckily for me, someone basically made a statement one day along the lines of, “People choose status over security,” and just like that I traded down and went back to a used car.
As Dave Ramsey puts it,
“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. Americans drive more than any culture 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.
4 Reasons You Should Never Buy New
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 home ownership your home is worth $240,000.
Most would be freaking out if they knew their house lost 20% of it’s value in one year. However, the same can not be said for car ownership.
2. Debt to income ratio.
If you have never heard of this, chances are you will when you go to buy your first home. Debt to income ratio refers to the amount of monthly debt you pay out 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.
For example, if you gross $4,000 a month and have $2,000 in payments, your debt to income ratio would be 50%.
Why is this 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. Hence why in my 6 things college graduates should know about money post, I tell recent graduates to never buy a new car.
Brian from Homespire Mortgage, a mortgage loan consultant, put it this way,
“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 debt to income ratio? Have no car payment.
Link to a Debt to Income Calculator
3. Cash is King.
The average person with a car payment will spent $479 monthly, or roughly $6,000 annually. That is a lot of cash that could be going elsewhere.
By not having a huge monthly auto expense you can throw more into savings, at student loans, or into retirement.
A common financial expert tip you will 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 above, never take money off the table with a new car purchase. The monthly 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.
Want to do something really cool with your extra cash flow ? Pay off your mortgage in 7-10 years by applying extra payments to your principal using this HELOC concept.
4. A new car is NOT and 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 then 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.
Why is a car a liability you might ask? For starters, the depreciation factor. An asset produces, it does not depreciate. A car owner should also expect to budget $99 a month for yearly car maintenance and tires.
When should you buy?
Most will 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. A simple way to guide you in buying your car is this:
As a general rule of thumb, your car should also never cost anywhere close to half your yearly 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 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 becomes unmanageable.
Live like no one else now, and you will live like no one else later.