Buying a car is potentially one of the biggest expenses of our lifetimes, outside of buying a home. So it is very smart to make sure you are making a wise decision when you set out to get a car.
The debate between buying a new car or a used car is no new debate. This debate has been going on for years, and it is quite a polarizing debate.
On the one hand, you have some people who prefer new cars because there will be less maintenance in the early years. Others who support buying new cars state that they prefer new cars because they plan to keep them for a long time, so they may as well benefit off the full life of the car.
On the other hand, there are some who are strong supporters of only buying used cars. These people argue that cars depreciate so much in the first few years, causing the new owner to lose so much value over that time period. So you end up getting a better value for the car, if you buy a car that is 2-3 years old.
So what makes the most financial sense?
Well, to answer this question, I resorted to a website called CarEdge.com. This site shows you the average depreciation for many different cars, by each individual make and model. According to Edmunds.com, the Honda Civic is the most popular car in America, so that is what I will use for this example.
Here is the depreciation chart for the Honda Civic from CarEdge.com.
Based on the chart, the Honda civic loses $3,693 in value, or 15.6% in the first year. So right away, as soon as you purchase this car, you are throwing away 15 cents on the dollar for some perceived increased value this car has. This is called the New Car Premium. Many people have ideas and thoughts in their heads about this superior value of new cars, so they are willing to pay a premium for new cars, even if the value is all made up in the mind.
But here's an insider tip: the New Car Premium does not actually exist! When you buy a car, you don’t know what you’re getting. Yes, you may get a car in perfect condition, but what if you don't? You don’t know what issues will come out with the new model year. Or maybe the model year is fine, but the car you purchased happens to be a lemon. There are so many unknowns with buying a new car, that you don’t have with a used car. When you purchase a used car, you’re able to see what you’re getting. You can see see if the previous owner took the car in for service at regular maintenance intervals. You can see what issues the previous owner had with the car, and why they had to take the car in to be serviced, outside of normal service intervals. You can also see if there is a leak or some other type of issue with the car, that could cause bigger issues down the road.
Think of it this way ... We all like to test drive cars before buying. With used cars, someone else is test driving the car for you, over several years, and they are getting more data points for you than you could get by test driving a new car over a one mile radius, with the car salesman sitting beside you explaining all of the benefits of the car.
Since used cars don’t have this perceived New Car Premium, your cost basis when you buy a used car is going to be much lower, and therefore you don’t take such a big hit on depreciation in your first year of owning the car.
Okay, back to the Honda Civic example. In Year Two, the Civic loses and additional $2,588 in value or 12.9%. So now, the car that you paid $23,726 for, is only worth $17,445, just two years later.
Let’s say, you keep the car for 10 years and you sell it at this time. The value in year 10 is: $6,657. That is 28% of what you initially paid for the car.
Now, let’s assume you purchased this Honda Civic when it was 2 years old. Now, you’re paying $17,445 for the car. We’ll also assume that you keep this car until it’s 10 years old, and sell it after this time. The value in year 10 is the same as in the example above: $6,657. This is 38% of that you initially paid for the car.
As you can see from the data, when you buy a car used, you are taking a lower hit on the initial purchase than someone who bought the car new. So overall, the you maintain more value when you buy a used car, versus buying a new car.
The data is a little bit different if you want to buy a luxury car. The data still supports that you should buy a used car, rather than a new car, but instead of purchasing after 2-3 years, you should purchase after 5-6 years, because at this time interval, you’re still getting into a nice car and it’s already taken the majority of its big depreciation hit.
So hopefully this data has helped you see the benefit of purchasing a used car, over a new car. Financially, a used car makes more sense. If this was a lot of analysis and it went over your head, remember this bottom line. Cars are depreciating assets. They lose value almost immediately, and in 99% of the cases, you will never be able to sell the car for more than you purchased it (unlike other assets, like houses). Since this is the case, you should aim to get the best value for the car, which is usually never found in new cars because of the depreciation factor.
Leave your comments below. I’d love to hear from you!
Until next time, stay S.M.A.R.T. about your finances!