Ok, we all have our pet theories and justifications for how we buy cars, but what I think gets a lot of people in trouble is the lack of an objective set of criteria and rules for really evaluating car purchases.
Background
The other issue is mind-set. What I mean here is the thought "I just like a new cars", or whatever excuse you tell yourself to buy more car than you can afford.
The following guide is for those that have little or no cash net worth and make less than $150,000 per year (which, unfortunately, is most people). The funny thing, most people you see driving around in nice cars, can't truly afford them. I think you can take some wisdom from this observation, I see a 2 year associate (attorney) driving a brand new Mercedes, yet Warren Buffet drives an 8 year old Lincoln Town Car.
1. Fact: Cars are depreciating assets, you will NEVER make money on owning a car.
2. Fact: There are two basic costs to owning a car. Acquisition cost and ownership cost.
3. Fact: Most cars made since 2002 will easily last 10 years or more with only basic maintenance and a few major purchases for tires and brakes.
4. Fact: Most cars depreciate in value on average of 40%+ during their first 3 years. (and many depreciate as much as 50%)
Acquisition Cost: This is the cost to actually acquire the car, price, taxes, initial registration. etc.
Ownership cost: This is the cost to maintain, drive, register, and insure a car.
Ownership cost is largely out of our control. Certainly, your choice of car model can determine if you pay more or less in ownership cost, but by-and-large, for any given car, ownership cost is a fixed amount.
Thus, what you have the most control over is Acquisition Cost. Acquisition Cost is not simply the price, what we have to consider is a way to put the price in context to provide some objective basis for selecting and buying a car.
My mindset for cars: (1) I need a car for transportation, a car is a tool (2) since I can never MAKE money with the car, my goal is to spend as little as is reasonable for owning a car, i.e. keep my cost low for the purpose for which I own a car...transportation. That is just good financial planning.
The method
In a nut shell, the "basic" formula I use for acquisition cost is this...
(Net Purchase Price - Estimated Future Resale Value) / estimated months of ownership.
The formula gets a little more complicated if you finance the car, but we will address that later. The formula is a way to amortize the acquisition cost for the amount of time you actually use/own the car.
Lets look at an example:
New car purchase: 2008 Mazda 3 Wagon. Gross Price (i.e. with tax, title etc), $22,000. (net price $19,500) Let's assume our buyer is like most Americans and only keeps the car for 36 months and lets assume the standard 40% depreciation. In 3 years, that car will probably sell for between $11,000 and $12,000 (I should point out, I am talking private party sale, trade-in would be significantly less). Thus, the Acquisition Cost (assuming this person paid cash) is $277.77 per month. (22,000 - 12,000) / 36
Used: 2004 Mazda 3 Wagon. Gross price $12,500 (net price $11,000). Average deprecation varies at this point, but it is about 5%-10%. Lets assume an average of 10% per year, estimated future resale value after 3 years is $8,000. Thus, the acquisition cost is $125 per month.
The net acquisition cost difference between the used deal and the new car deal is $5,500. That $5,500 is the amount you keep in your pocket by minimizing your acquisition cost of a car.
Obviously, the longer you keep the car, the lower the amortized acquisition cost will be. But even if you kept the NEW car for SIX years, your amortized acquisition cost is still $194.44 per month. Thus, in many buying scenarioes, you still come out ahead buying a used car and owning it for 3-4 years than buying a new car and owning it for even six years.
Other considerations:
1. To make this formula truly work in your favor, you have to find the right car AND the right deal. You generally need to find a lower mileage car that is in good to excellent condition.
2. Many buyers tell themselves that used cars cost more to upkeep. Not "necessarily" true. First, you have to realize, you don't use this method for any old clunker, this method forces you to find the "right car, the right deal". It takes some leg work. When I shop for a car, I will generally spend about a month until I land on the right car. The ownership costs between new and used wash themselves out in this way. It is true, you are likely to have a couple of "bigger ticket" upkeep costs with a used car (probably tires and brakes), but those costs are offset in that new cars are more expensive to insure, register, and if applicable, taxes or more. Thus, even if you have some major repairs, odds are, you will still not eat into the savings from the Net Acquisition Difference.
3. If you must finance, the only change in the formula is you have to add-in interest to the Gross Price.
4. Never ever finance a car (new or used) with zero down. At a "minimum", you must put at least enough down to cover tax, title and other finance related charges.
5. The endgame with this formula is to allow you to have some cash on the back-end to buy another car.
6. By using this formula, and finding the right car and the right deal, is about the closest you can come to coming out ahead on car ownership.
7. Under this method, leasing never makes sense (basically, you are paying for the most expensive years of the car's life).
8. If you buy from a dealership, don't be afraid to get up and walk away. You will be surprised how fast the numbers come down as you start walking out.
9. If at all possible, try to pay cash for a car. I realize that paying cash is tall order these days, but if you can save up, try to do so. If you do this right, you will get some of that cash back on the back end. If you do this plan correctly, along with other frugral financial management techniques, you can perpetually buy a car every 3 to 4 years.
10. The process assumes that when you re-sell the car, you do so as a private party sale and not a trade-in. (but you can still run the numbers on trade in value, but you minimize your acquisition cost by selling private party).
Affordability
How much car can you really afford. To figure this out, you need to budget budget budget, and research research research.
Rule of thumb...if you finance a car (or if you look at the monthly Acquisition cost), your payment should not exceed 5% of your gross monthly income. Why so low, because ownership cost will easily eat up another 5-10% of your gross monthly income (i.e. gas, insurance, registration, taxes, upkeep). Thus, in keeping to my example. The person who bought the "new car" would need to make $5,555 per month. The used car buyer need only make $2,500 per month.
The truly wealthy people I know also make similar considerations, but do so a little differently. The truly frugal wealthy people I know (they are wealthy because they are frugal), will use a percentage of net cash worth in deciding how much to spend on a car. They generally will pay no more for a car than 0.5%- 1.0% of their "cash" (or liquid) net worth. To put that in perspective, a person with $10MM in liquid assets will not spend more than $50,000-$100,000 on a car. But most wealthy individuals I know tend to draw the line at about $60,000. In addition, they tend to keep their cars longer, usually about 5 years. In any event, they all have objective criteria for minimizing the cost of acquisition and have rules about how much they are willing to spend on a car.
In any event, that is my advice for how to go about and at least analyze how to buy a car. The overall point is, do not take car buying lightly. I use this method because it is objective, it meets my needs, and gives a true picture of what I am paying for a car.
Any similarity to any other persons car buying advice is incidental, this method I came up with on my own and I have not researched other published articles on car buying methods
Feel free to reply or add your insight.
Background
The other issue is mind-set. What I mean here is the thought "I just like a new cars", or whatever excuse you tell yourself to buy more car than you can afford.
The following guide is for those that have little or no cash net worth and make less than $150,000 per year (which, unfortunately, is most people). The funny thing, most people you see driving around in nice cars, can't truly afford them. I think you can take some wisdom from this observation, I see a 2 year associate (attorney) driving a brand new Mercedes, yet Warren Buffet drives an 8 year old Lincoln Town Car.
1. Fact: Cars are depreciating assets, you will NEVER make money on owning a car.
2. Fact: There are two basic costs to owning a car. Acquisition cost and ownership cost.
3. Fact: Most cars made since 2002 will easily last 10 years or more with only basic maintenance and a few major purchases for tires and brakes.
4. Fact: Most cars depreciate in value on average of 40%+ during their first 3 years. (and many depreciate as much as 50%)
Acquisition Cost: This is the cost to actually acquire the car, price, taxes, initial registration. etc.
Ownership cost: This is the cost to maintain, drive, register, and insure a car.
Ownership cost is largely out of our control. Certainly, your choice of car model can determine if you pay more or less in ownership cost, but by-and-large, for any given car, ownership cost is a fixed amount.
Thus, what you have the most control over is Acquisition Cost. Acquisition Cost is not simply the price, what we have to consider is a way to put the price in context to provide some objective basis for selecting and buying a car.
My mindset for cars: (1) I need a car for transportation, a car is a tool (2) since I can never MAKE money with the car, my goal is to spend as little as is reasonable for owning a car, i.e. keep my cost low for the purpose for which I own a car...transportation. That is just good financial planning.
The method
In a nut shell, the "basic" formula I use for acquisition cost is this...
(Net Purchase Price - Estimated Future Resale Value) / estimated months of ownership.
The formula gets a little more complicated if you finance the car, but we will address that later. The formula is a way to amortize the acquisition cost for the amount of time you actually use/own the car.
Lets look at an example:
New car purchase: 2008 Mazda 3 Wagon. Gross Price (i.e. with tax, title etc), $22,000. (net price $19,500) Let's assume our buyer is like most Americans and only keeps the car for 36 months and lets assume the standard 40% depreciation. In 3 years, that car will probably sell for between $11,000 and $12,000 (I should point out, I am talking private party sale, trade-in would be significantly less). Thus, the Acquisition Cost (assuming this person paid cash) is $277.77 per month. (22,000 - 12,000) / 36
Used: 2004 Mazda 3 Wagon. Gross price $12,500 (net price $11,000). Average deprecation varies at this point, but it is about 5%-10%. Lets assume an average of 10% per year, estimated future resale value after 3 years is $8,000. Thus, the acquisition cost is $125 per month.
The net acquisition cost difference between the used deal and the new car deal is $5,500. That $5,500 is the amount you keep in your pocket by minimizing your acquisition cost of a car.
Obviously, the longer you keep the car, the lower the amortized acquisition cost will be. But even if you kept the NEW car for SIX years, your amortized acquisition cost is still $194.44 per month. Thus, in many buying scenarioes, you still come out ahead buying a used car and owning it for 3-4 years than buying a new car and owning it for even six years.
Other considerations:
1. To make this formula truly work in your favor, you have to find the right car AND the right deal. You generally need to find a lower mileage car that is in good to excellent condition.
2. Many buyers tell themselves that used cars cost more to upkeep. Not "necessarily" true. First, you have to realize, you don't use this method for any old clunker, this method forces you to find the "right car, the right deal". It takes some leg work. When I shop for a car, I will generally spend about a month until I land on the right car. The ownership costs between new and used wash themselves out in this way. It is true, you are likely to have a couple of "bigger ticket" upkeep costs with a used car (probably tires and brakes), but those costs are offset in that new cars are more expensive to insure, register, and if applicable, taxes or more. Thus, even if you have some major repairs, odds are, you will still not eat into the savings from the Net Acquisition Difference.
3. If you must finance, the only change in the formula is you have to add-in interest to the Gross Price.
4. Never ever finance a car (new or used) with zero down. At a "minimum", you must put at least enough down to cover tax, title and other finance related charges.
5. The endgame with this formula is to allow you to have some cash on the back-end to buy another car.
6. By using this formula, and finding the right car and the right deal, is about the closest you can come to coming out ahead on car ownership.
7. Under this method, leasing never makes sense (basically, you are paying for the most expensive years of the car's life).
8. If you buy from a dealership, don't be afraid to get up and walk away. You will be surprised how fast the numbers come down as you start walking out.
9. If at all possible, try to pay cash for a car. I realize that paying cash is tall order these days, but if you can save up, try to do so. If you do this right, you will get some of that cash back on the back end. If you do this plan correctly, along with other frugral financial management techniques, you can perpetually buy a car every 3 to 4 years.
10. The process assumes that when you re-sell the car, you do so as a private party sale and not a trade-in. (but you can still run the numbers on trade in value, but you minimize your acquisition cost by selling private party).
Affordability
How much car can you really afford. To figure this out, you need to budget budget budget, and research research research.
Rule of thumb...if you finance a car (or if you look at the monthly Acquisition cost), your payment should not exceed 5% of your gross monthly income. Why so low, because ownership cost will easily eat up another 5-10% of your gross monthly income (i.e. gas, insurance, registration, taxes, upkeep). Thus, in keeping to my example. The person who bought the "new car" would need to make $5,555 per month. The used car buyer need only make $2,500 per month.
The truly wealthy people I know also make similar considerations, but do so a little differently. The truly frugal wealthy people I know (they are wealthy because they are frugal), will use a percentage of net cash worth in deciding how much to spend on a car. They generally will pay no more for a car than 0.5%- 1.0% of their "cash" (or liquid) net worth. To put that in perspective, a person with $10MM in liquid assets will not spend more than $50,000-$100,000 on a car. But most wealthy individuals I know tend to draw the line at about $60,000. In addition, they tend to keep their cars longer, usually about 5 years. In any event, they all have objective criteria for minimizing the cost of acquisition and have rules about how much they are willing to spend on a car.
In any event, that is my advice for how to go about and at least analyze how to buy a car. The overall point is, do not take car buying lightly. I use this method because it is objective, it meets my needs, and gives a true picture of what I am paying for a car.
Any similarity to any other persons car buying advice is incidental, this method I came up with on my own and I have not researched other published articles on car buying methods
Feel free to reply or add your insight.
, and while having a car that is under a good warranty is a nice piece of mind, nothing beats not having a car payment. At the end of the day, as long as a vehicle can get someone from point A-B and back safely, that is all that matters. I'm done trying to impress people. I do appreciate the attention my car garners, but at the end of the day, it doesn't make me a better person, and lightens my wallet more than I'd like it to. My current vehicle gets in excess of 33+MPG (it's only saving grace), but I bought it new, so that payment combined with the cost of gas is really painful. 
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