Spring is around the corner (I hope) and so are tax refunds! If you are like many Americans, you might feel that it’s time to replace your sedan or minivan and get a newer model. Our 2004 Town & Country has about 137k miles on it, so we are just about getting to that point ourselves. [Note: For this article, I’m not going to get in to the details of HOW to buy a car (cash, loan, lease); that will be for a different post.]
If you are potentially in the market, here are some common statements you may have heard about car buying. Some are true, some are not. Let’s examine each of them:
1. It is financially better to buy used. TRUE. This shouldn’t surprise many of you, but I don’t recommend buying a new vehicle. You will always pay less money if you buy a used vehicle. The first year depreciation is huge; and actually the first 5 years of depreciation are pretty substantial. This depreciation will vary based on the type of car and how well it is maintained… but it makes sense to let someone else take the hit, and then you can buy the car once it is ‘worn in’.
If you buy a car that is only 2 years old instead of a new car, you can save a substantial amount of money. The following chart illustrates the change in value of vehicle over time. Each line represents the same vehicle, but purchased at different points in time. The orange line represents the value of a $25,000 car purchased brand new. The green line represents the value of that same car purchased 2 years old, and the purple 5 years old.
As you can see, if you buy a 2 year old car, you will pay $8,000 less up front. And if you keep the car for 5 years, your vehicle would be worth $2,700 less. Over those 5 years, you will have saved $5,300 in depreciation costs ($8,000 – $2,700). If you buy a 5 year old car or keep the it longer, those savings will be even greater. Yes… there’s that ‘new car’ smell and feel, and it’s shiny and nice… but I’m simply not willing to pay thousands of dollars for that. Besides, after 6 months that feel is just about gone.
2. It can be financially smart to buy a new vehicle if you plan on owning it for a long time. FALSE. I’ve heard this one repeated by many sharp financial people, and I simply couldn’t disagree more. Let’s expand the chart that we used above to 12 years:
Again, comparing the $25,000 brand new car to the same 2 year old car – you will see a difference in price of $8,000 immediately. But something happens with compound depreciation – as a car ages past 10 years, a difference of 2 or 3 years in age doesn’t mean much in terms of value. This makes sense when you think about it… what is the difference in value of a 12 year old car and a 14 year old car? All things being equal, not that much; they are both only worth a few thousand dollars. At this point in the life cycle of a vehicle, the things that determine it’s value are miles, condition, how well it has been maintained, etc.
So here is my question: If you plan to keep a car for 10+ years, why would you spend the additional $8,000?
3. The best time to buy a car is at the end of the year. TRUE. This is true for both used AND new vehicles. If you recall from your economics course in high school or college a while back, you might remember the concept of supply and demand. When there is a higher demand for something (i.e. more people want it), then the price rises. Tax return time has that effect on car buying. Many people are waiting to get that large chunk of cash to buy or put a down-payment on a vehicle, so the price of vehicles is higher in the spring than in any other time of the year.
If you are in the market for a minivan, the effect is even worse. Families in need of a minivan typically have more tax deductions (i.e. children) which results in a larger tax return, and more incentive to shop in the spring than buyers of other types of vehicles.
A much better time would be in the fall or beginning of winter. As the weather gets cooler, people generally aren’t as excited to be getting a newer vehicle, and the ‘tax refund effect’ isn’t in play. In fact, did you know that some people can make a full-time income simply from buying minivans in the fall and selling them in the spring? That should tell you something about the seasonal difference in price.
In the case of new vehicles, many dealerships are getting ready for the following year’s models and want to clear the floor of the current models. So, you might want to take your tax return, deposit into a separate account (so you don’t touch it), add more money to it if you can, and wait until the right time. You can probably survive another few months in your old vehicle.