Cars can make or break a person’s finances. While most people need reliable cars to get to work, the types of cars that we purchase, the method of purchasing them and the age of the cars can extremely alter the cost-effectiveness of purchasing one. In this post, I will cover the issue of purchasing a new car with a loan compared to simply buying a second-hand one outright. I will also tell you how to make the most cost-efficient purchase on a car based on depreciation statistics.
The first thing to note with cars is that they are rapidly depreciating assets, meaning that their value lowers significantly over time. In fact, a study in the US found that on average, most new cars depreciate to half of their original value within five years. Additionally, some depreciate at an even faster rate. This can be disastrous for people who have used a car loan, as the interest paid on the loan, in combination with the length of the loan can result in you paying more than twice the value of your car by the time you actually own it.
Let’s say that a new car has caught your eye that costs $50,000 but you simply don’t have the money saved up. If you borrow the $50,000 through a car loan at an interest rate of 7.5%, with a loan duration of five years then you would be paying monthly installments of $1,002 per month for five years. By the time that you pay off this loan, you would have spent $60,114 to own your car that was originally valued $50,000, meaning you paid 120% of the initial value of the car.
Here’s the kicker though, during the five years that it took for you to completely pay off your car loan and own your vehicle, it depreciated by 60% and now its value is $20,000. By this point, your $60,114 paid to own your $20,000 car represents an overall cost of 300% of the car’s value based on the loan.
Now depreciation isn’t an endless cycle after that 60% drop most cars tend to hover around that 40% mark, assuming they are well looked after and don’t have insanely high mileage. They will continue to drop over time, but do so at a much slower rate, so most people agree that five year old vehicles are typically the most cost-efficient purchases. So let’s assume that rather than buying the car the year that it’s released with a $50,000 loan, that you instead put aside money into a savings account over a five year period. How long would it take you to save up the money to purchase the car for $20,000 after someone else bought the car at its maximal value?
Assuming that you have a savings account that has an interest rate of 2% (Currently, this is UBank, Xinja and BOQ), all it would take is putting aside $150 fortnightly to be able to have enough money to own the car outright, with enough left over to cover the registration for six months.
If you are simply getting a reliable car to get you from Point A to Point B, then saving your money is definitely the logical choice. In fact, you can reliably do this with older, smaller cars and pay well under $10,000 to get a car that meets your needs. If you took this approach, it would take you less than 3 years to save that amount using the above figures.
At the end of the day, if you have the disposable income and collect or drive cars for a hobby, then perhaps you may want to purchase brand new cars. But for most people out there who need a car for work and to fulfil simple tasks like going to the shops or driving to the beach, it will often be in your best interest to save up your money and buy a good quality, low mileage, second-hand vehicle that’s approximately 5 years old.
Here are the different calculators used for the calculations if you would like to test and compare them to match your own circumstances: