Conventional wisdom might say there is more value to be had in a used car, after all, the worst depreciation happens in the first few years after purchase and then levels off in later years. While this is true in theory, in the long term there are some other significant factors that can change the equation.
Before we begin, if you are not in a good financial position then do not buy new. Buying new while not having your financial house in order is much worse than buying used when you do. The following are prerequisites that have to be in place for it to make sense to buy new:
-you have excellent credit
-you bring at least 3 to 4 times the car’s price in annual income AND have a good savings rate (i.e., you have the ability to pay for the car in cash, even though you may not want to – more on that later)
– you will be happy with the car for a long time, and won’t be tempted to trade it in too soon
-you maintain your cars properly
-you are planning to buy a standard car from a reliable brand (meaning Honda or Toyota); not a luxury car.
If you meet the above criteria it’s probably a better bet to buy new in terms of value. Here’s why:
- Transaction costs. There are costs incurred with each transaction of buying or selling a car, and when you buy used, you will need to buy more often. Used cars will naturally last for fewer years than a new car would since they are older when you purchase them. Therefore, during a 10 year period you may buy (and sell/trade-in) two used cars during the same time that, had you bought new, only needed to buy/sell one new car. When you buy a used car, you have to incur a dealer’s markup. Then when you sell the car (trade it in) back to the dealer, again you are dealing with a lower offer from the dealership. Going through this buying/selling process fewer times will be much more cost effective. There are other costs associated with each transaction such as taxes and fees when you purchase a car.
You might be able to mitigate some of these transaction costs by buying from private party sellers, and selling to private parties, but this is a lot more work on your part and you may be taking on additional risk as there won’t be a warranty program that a private party can offer. Speaking of risk….
- Higher risk. When you buy a used car, you are inherently taking on more risk that the car was not well maintained or was involved in some accident or sustained some damage that was not reported. Used cars may not last as long as cars you owned since they were new (assuming you properly maintain your cars).
- Opportunity costs. If you have excellent credit, new cars can often be bought with manufacturer financing at 0%, 0.9% or 1.9%. This is essentially a loan for less than the rate of inflation. With used cars, interest rates are much higher. I definitely do not endorse taking a car loan out unless it is at an extremely low interest rate (i.e., below inflation rate). You can then use the upfront savings to invest in assets such as stocks. (I go into this idea further in my post about prepaying mortgages). Again, this also assumes you are disciplined at saving, and will not blow the money that you save upfront on other expenses.
So there you have it. If you have bad credit, a lower income and savings rate or are not quite as disciplined yet with money, then a used car is your best bet. But if you have good credit, high income/savings and are good with money, then in the long term it’s better to buy new, hold for at least 10-12 years and trade-in for a newer model at that point. Just remember to buy reliable cars (read: Honda or Toyota), maintain those cars properly and don’t buy more car than you need/can afford.
