In the vast open space of personal finance and especially in the FIRE community, they often shout, don’t do it, only buy used cars. Now for my whole life, I have only ever driven used cars. I run each of them into the ground, receiving $50 for scrap metal. I hope to challenge the status quo, on when buying a new car is actully ok, or if you should stick to a used car.
My first car was a 2000 Toyota RAV4 in metallic green; it had just over 100,000 km on the clock. I loved that car; it was my first taste of freedom as a young adult. The clutch finally gave out, costing more to replace than the worth of the car.
The thing with old cars, once they go, they go. I had to find a new car fast. Being in the FIRE mindset of, “I will never buy new”. I jumped into a 2014 Toyota RAV4 with the thought being, if it’s anything like my last car, I’ll be set up for the next ten years. It has reached over 150,000 km now on the clock, and I am starting to worry. The Gearbox is skipping gears left right and centre.
This triggered me to self-evaluate if buying a new car would be worth it for our family. On my journey, I discovered 10 rules I applied to help make that decision.
This guide is going to challenge the FIRE community about why buying new is sometimes the smart choice. But do remember to do your research and crunch the numbers, as finance is personal.
When Should You Buy New or Used?
It’s important to remember that any given sum of money is relative. Not everyone is at the same stage in their FI journey. I don’t like to say I am Financial independent. I am very asset rich cash poor. But if I was to sell everything tomorrow, I could happily live off my money. That to me is not FI. FI to me is when my assets pay for themselves, and I don’t need a job.
However, I am lucky enough to have a high net worth. Spending close to $45K on a new car will only affect my net worth by 3.6%. Dave Ramsey recommends only buying a new car until you are a millionaire.
Look at this chart to see the impact on your net worth with a purchase of a common Landrover Discovery, Hybrid Rav4, Hybrid Corolla and the cheapest car on the market.
The chart clearly is showing that you should not be buying a new car in the lower net worth brackets. But sadly, this is all too common, where most people are buying new cars. For example, buying a $45k Rav4 when you have a net worth of 100k will see nearly half of your assets depreciating rapidly. Let alone it’s probably financed and it’s the only “assets” they own.
I see a lot of people driving expensive cars for status, IE my Land Rover Discovery being part of the table. I often feel the people that drive them are not multi-millionaires, as they are far too common. If you feel like you need a status car, you need to stop and evaluate why you need an expensive car.
Buying new or expensive cars when your net worth is still at the beginning, is only going to make you poorer. Setting you back years towards financial independence. Either way, if buying a new car doesn’t impact your level of financial freedom then I think there’s merit to the new car decision.
Rule 1: Don’t buy new until you are a millionaire, or the net worth purchase percentage is under 5%.
One major concern I had with buying a new car, is the eventual loss of value called depreciation. This is also a large talking point in the financial independence movement. A lot of regular folks worry about fuel economy, fancy features or if the next model up with worth it.
It’s hard to wrap my head around losing 15% of my car worth every year for the first 5 years. If I was losing 15% of my portfolio every year this would be disastrous. Usually, a car will lose half of its worth in the first 5 years, then balances around 40% of the purchase price. Every car is different though, and it usually plateaus after that. The table below shows the values and the loss of each year for 5 years.
One of the main issues that consumers come with buying a new car is the desire to buy another new one every 4 or 5 years. This practice of buying a new car every 5 years is going to take its toll on your finances. You are committing yourself to lose 15% of your net worth for your entire life if you keep buying new cars. This is hard to stomach how much you lose due to depreciation.
However, it must be stated that a new car is a good, not an investment. You need to see buying cars as like buying a new fridge. It has a purpose, and that purpose is not to make you money.
Until I fully understood that depreciation doesn’t matter, then did I start to see the benefit of a new car. This is because I am going to drive this car into the ground. I don’t need to worry about the value of my car if I plan to never sell it. If you are worried about depreciation still, here are three tips to help.
- Choose a brand car that is known to be reliable and a workhorse, as these depreciate slower. Japanese brands such as Honda and Toyota for example. And don’t buy luxury European brands, as they have the highest maintenance costs and depreciation loss.
- Buy car features that matter in a used car market. This can be choosing a natural colour, tow ball/hitch. As these can make your car more attractive to buyers.
- Complete regular maintenance and service records. This should go without saying, as preventative maintenance is the best maintenance. Keeping your car well tunes prevents unexpected large costs anyway.
Rule 2: Your car is not an asset or investment in a financial sense. But it can be an investment in your family or lifestyle.
Rule 3. Depreciation doesn’t matter if you never sell. Run it into the ground.
Most buyers are financing their vehicle over 5 or 6 years for the full amount of the car’s worth. This with car depreciation will land you into a negative equity zone. Meaning that you will owe more than the car is worth. The majority of buyers perpetually buy a new car every 5 years with financing, never getting to experience having no debt.
Financing can work if done right. There should only be three things you use debt for, a mortgage, margin loan or a car loan. And with borrowing money for any of the three, you should not borrow until all consumer debt is paid for. You should not have any credit or personal loans before leveraging. But that’s a whole different story to this. As a result, most folks who buy a new car wind up feeling like their car owns them instead of the other way around.
Now I did use finance for my car, even though I could have purchased it outright. here is why.
I have no consumer debt: I use a lot of debt in my FI strategy, but no forms of consumer debt. If you have any form of consumer debt, this can be in the form of personal loans, Credit cards or after payment, then your priority is to eliminate this debt. You should also not be considering buying a new car if you are in consumer debt. This is where a good used car over the age of 5 years is worth it.
Interest is at an all-time low: I was able to secure a loan for 3.97% over 5 years. Totalling $460 a month. I am not suggesting because money is so cheap now that you must borrow, but it sure does help.
Having a 3.97% rate compared to a big four bank of 6.99% is dramatic. Finding the lowest rate possible in my situation found me saving $3000 in interest.
One of the reasons why I was able to get the cheapest car loan on the market was because of buying a green vehicle. Loans.com.au have a product called green car loan, giving a .7% discount on electric and hybrid cars. They also have no ongoing fees or discharge fees.
I can afford to spend $460 a month on a luxury. But this is money I am not investing, also called opportunity cost. More on that later.
Didn’t want to spend all my cash: I did not want to fork over half of my cash savings over into a good. Also, remember earlier about depreciation, I did not want to be in negative equity ever. So, I placed a 50% deposit down. This allows my funds to be flexible to use.
I plan to pay it off in 4 years: Loans.com.au does have an early termination fee. $700 in the first 2 years, $500 in years 3 and 4 and no fee for early termination in the final year. The reason for such a high early termination fee in the first few years is that where the bank makes its money from. You will always pay higher interest at the beginning of the loan.
I plan to adjust my payment schedule to $260 a fortnight from $212. Allowing me to reach 4 years and save a few hundred dollars off my interest payment.
This is a loss of $2,057 (.002% of net worth) off interest over the life of the loan, or $20 a fortnight for the luxury of using someone else money. Plus, I am saving more than $2000 in fuel a year now with my hybrid car.
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Rule 4: Do not think of buying a new car if your finances are not to ship shape. Ensure you have no consumer debt.
Rule 5: Pay a 50% deposit. This will stop you from having negative equity, while also lowering your interest payment.
Rule 6: Make sure you get the lowest interest rate and pay it off sooner. This can save you thousands.
I paid $70 the other day at the petrol station, I used to do this every week. It hit me that day, I don’t know why. But $70 a week is $3640 a year. And that was my largest expense after groceries.
I believe fuel prices will keep going up, trends have seen a rising fuel price in Australia over the past 20 years. We only have a finite number of resources, and the destabilising of the Middle East will only see our prices increase. Sydney reached a record this year (2021) and hit $1.76 a litre. That would have seen me paying close to $80 for a tank of fuel.
The table shows yearly average national fuels prices and the trend line showing a general increase in fuel prices.
With my belief, that’s why I decided to buy a more fuel economical car. I have always said that if I was to buy a new car it would have to be a Hybrid. The fuel savings and looking after the environment was the crux of my new car purchases. If my new car wasn’t a hybrid, I would still be driving a used car.
My Toyota RAV4 hybrid is averaging around 4.8 L/100. That’s a mass difference compared to my 10L/100 I was getting on my old car.
I now only refuel every 2 and half weeks, compared to weekly. My fuel costs have plummeted to an average (if fuel prices never fluctuated from today) of $1400 a year. That’s saving me $2240 a year in fuel alone. And if my inner Nostradamus comes through with higher prices, that’s even further savings.
Rule 7: Buy a car with fuel economy in mind
Hybrid or Electric Vehicle
You can certainly opt to buy a used electric vehicle. But EV’s have come a long way in the last five years. So, a new EV will have a longer range and better features. Electric vehicles will save you money every month at no fuel cost. But the main issue I find with EV is that they are missing much-needed infrastructure.
The Australian Government does not support EVs currently, and with very limited fast-charge stations around the country, they just don’t make sense. Also, the government is not giving any financial initiatives via rebates or tax credits to make them worthwhile. If you want to read more I suggest this ABC article.
Therefore, I went Hybrid; I was able to still use a combustion engine and use a battery to supplement some power. Plus, with the rise of hybrids, the economy of scale has happened and manufacturers can supply hybrids at a reasonable price. There is not much sense to buy an EV in Australia until they are cheaper, and the government supports the infrastructure.
If you are looking at a hybrid, my suggestion would be to look at the Toyota range. They have been producing hybrids since 1997, with the Prius model NHW10 release. They have been the leaders in hybrid technology. With impeccable reliability and performance. Toyota has a 10-year unlimited-kilometre warranty on their batteries and a 7-year engine and drive train (if serviced by Toyota). To me, that means they are confident in their engineering.
My very first car was a Toyota Rav4 that lasted 22 years with 350,000km on the clock. It had no mechanic issues at all, until the clutch started to slip, and would cost more than the car is worth. For this reason alone, is why I choose Toyota?
Insurance is Higher
Buying used will save you money on car insurance. We’ll close with this one because a lot of car buyers forget to factor this into the equation and then suffer the sticker shock from the steep insurance premiums that come with a new car.
Drivers of new cars often get stuck with higher-than-average premiums. Because new cars are more costly to repair or replace, they also cost more to insure. Even with some of the latest safety technology, insurance companies rarely offer discounts to new-car drivers for having those features.
While new-car drivers will spend roughly over $1000 a year on car insurance premiums. You could save 12% on insurance premiums if you buy a five-year-old version of the same car.
The best value for money car insurance I could find was Youi. They offered me $782 a year for car insurance.
I view insurance to cover me for very expensive occurrences. Total of my or someone else’s car, or huge structural damage to my houses. Therefore, I bump my excess to the maximum and self-insure through an emergency fund for minor incidences. My excess for fully comprehensive car insurance is $2,500.
Rule 8: Insurance is going to cost more, the more expensive a car is.
Maintenance is Cheaper
With purchasing a new car, you are guaranteed to work for a certain amount of time with its given warranty. Most car manufacturers come with a form of warranty, Toyota for example comes with a 7-year warranty on the engine and drivetrain. And a 10-year warranty on the battery system itself.
This gives me confidence as a consumer that they trust their brand name.
Another benefit with new cars is a yearly servicings or 15,000km, compared to half that previously. Coupled with fixed cap servings, maintenance costs are significantly less than a used car 5 years or older.
Opportunity cost is the forgone benefit that would have been derived by an option not chosen. For example, if I didn’t buy a new car, and instead invested that $45,000 money for 10 years, then my opportunity cost will cost me $36,872 in performance gain, and more the longer it’s invested.
I am choosing to forgo $36,872 on top of my $45,000. Obviously, buying a used car, or a less expensive car has less effect on opportunity cost. For example, buying a used car for $15,000 will still cost me $12290 in opportunity cost.
Buying a new car can make sense in some situations, but it seldom makes the most sense from a number’s standpoint. That is in part because of the opportunity cost associated with your purchase. That means that your new car payment will prevent you from investing your money in ways that will have a massive benefit on your financial future. If you want to dig even deeper into that decision this opportunity cost calculator is very helpful.
Rule 9: Calculate your opportunity loss, and make sure you are comfortable with that number.
You Need to Find the Total Cost of Ownership.
The biggest thing you should consider when buying any car is the likely total cost of ownership. Doing up a spreadsheet gives you an apples-to-apples comparison of the car you are considering. I produced a spreadsheet that listed what it would cost if I leased, used cash, or borrowed money. You might be surprised at the numbers you encounter as you compare potential vehicle purchases.
I made a spreadsheet outlining the usually costs to run the RAV4 hybrid off projected costs, depending on if I leased (through salary sacrificing), paid with cash, or borrowed a portion or all.
I itemised the costs based on real-world quotes I received, then simulated it into 5 different finance options. Note, I could have paid for this outright, but was not comfortable spending it all and depleting my emergency/savings account.
Interesting I found salary sacrificing a new car was not feasible. Maybe for ultra-high earners? However, I was finding it the second most costly, second to borrowing all the money from the bank. That doesn’t surprise me, of course, it’s going to be a slight difference between the two, due to tax credits.
This is where I settled on the $25k loan, as it was a happy medium. The expense and interest charges were not that much more. Plus, with the ultra-low interest rates, it’s a good time to be borrowing,
Rule 10: Calculate the operating cost.
Why Did I Buy a New Car?
I always said I will only ever buy a new car if it’s a hybrid. I’ll admit, this purchase is a bit of a want than a need. I do not need a new car. However, the maths and my circumstances it is worth the purchase in my view.
After doing the maths, there is a difference of $3,283 a year. The majority of this comes from car payments. The day to day running costs are cheaper to buy a new car than a used one.
If I choose to get a less expensive new car and purchased it with cash it would make financial sense to buy new over used. But at the end of the day, I wanted to enjoy my money and treat the family.
I hope you have gained insight into my reasons for buying a new car. Ultimately, if you are in the wealth-building phase of your life, you should likely opt to buy a used car. And if you buy a used car that is roughly a decade old, you’ll put yourself in an even better financial situation. I’d still encourage you to purchase a well-loved used car and to drive it for the next decade. But if you ignore depreciation the longer you plan to own a new car the less of a strain it puts on your finances.
Putting your hard-earned money to work for you instead of sinking it into a rapidly depreciating asset will have major ramifications on your ability to achieve financial independence. The value of that money invested in index funds for the next 30 to 40 years instead of shovelling that cash towards a car payment will give you freedom and peace of mind.
However, at the end of your finances are personal. You need to enjoy your money, I am lucky enough to have reach Semi-FI, and can afford to buy a new car. The new car brings happiness to a long journey to FI. This car brings adventure, enjoyment of driving, environmentally conscious and peace of mind. But if you are still on the path to freedom. Buy used and love it. Just know that one day you can enjoy treating yourself later.
The 10 Rule Summary
1: Don’t buy new until you are a millionaire, or the net worth purchase percentage is under 5%.
2: Your car is not an asset or investment in a financial sense. But it can be an investment in your family or lifestyle.
3. Depreciation doesn’t matter if you never sell. Run it into the ground.
4: Do not think of buying a new car if your finances are not to ship shape. Ensure you have no consumer debt.
5: Pay a 50% deposit. This will stop you from having negative equity, while also lowering your interest payment.
6: Make sure you get the lowest interest rate and pay it off sooner. This can save you thousands.
7: Buy a car with fuel economy in mind
8: Insurance is going to cost more, the more expensive a car is.
9: Calculate your opportunity loss, and make sure you are comfortable with that number.
10: Calculate the operating cost.
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