How much should you spend on a car?

What if we started spending all of our paychecks instead of saving half of them? What if we started living paycheck-to-paycheck without regard to savings or investments or financial independence?

 

After all, everyone else is doing it!

 

With all that money, we could drive brand new cars to work. Nothing fancy but we could finance a 2018 Honda Civic sedan and, since everyone else is doing it, an SUV to go with it.

 

How much should you spend on a car?

After sales tax and fees, a Honda Civic would only cost us $451 per month to finance for 5 years.

 

Source: Honda Canada

 

But then again, why would we tie ourselves to a loan for only 5 years when we can make it last 7 years and only pay $348 per month? The interest rate jumps to 5.14% but why look at this when the payments are so low and they do not even require any down payment?

 

We could do the same for a nice Jeep Grand Cherokee. Let’s stick with the base model for this one. The next purchase price comes down to $43,640. Oops, I mean only $587 per month for 7 years!

 

 

Forget I said anything about the price and focus on this nice low figure instead. You know what; we can even get a deal for only $121 per week for 8 years! How generous of Jeep. Allowing us to only pay $121 per week for the next 8 years of our lives and they even keep the interest rate at 3.49%.

Buying cars that we cannot afford to pay for cash would mean that we end up paying a ton of interest to the bank. Over a five year period, a 5% interest rate means that about 12% of the monthly payments go towards interest.

After all this fun shopping, we could be driving around town with sweet rides, base models but brand new base models, for a total of $935 per months for the next 7 years. This represents $11,223 per year.

Now, if we keep investing this amount instead, we would end up with a whopping $102,243 after only 7 years. This assumes 7% annual returns after inflation which is very close to what the American markets returned for the past few decades.

 

Source: Bankrate

 

Unlike the value of these cars, the value of these investments is historically likely to increase over the long-term. If we look at the depreciation and maintenance costs of these vehicles over a few years, investing the money looks even more attractive.

 

2017 Honda Civic

5 Year Details	Year 1	Year 2	Year 3	Year 4	Year 5	5 Yr Total
Depreciation	$6,070	$2,005	$1,765	$1,562	$1,402	$12,804
Interest Charges	$667	$667	$667	$667	$667	$3,335
Taxes & Fees	$1,414	$73	$73	$73	$73	$1,706
Fuel	$1,000	$1,000	$1,000	$1,000	$1,000	$5,000
Insurance	$829	$858	$888	$919	$951	$4,445
Maintenance	$132	$520	$365	$883	$1,175	$3,075
Repairs	$0	$0	$104	$247	$361	$712
Total						$31,077

Adapted with data from: Edmunds

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2017 Jeep Grand Cherokee

5 Year Details	Year 1	Year 2	Year 3	Year 4	Year 5	5 Yr Total
Depreciation	$9,093	$3,447	$3,031	$2,685	$2,407	$20,663
Interest Charges	$796	$796	$796	$796	$796	$3,980
Taxes & Fees	$2,509	$111	$111	.$111	$111	$2,953
Fuel	$1,800	$1,800	$1,800	$1,800	$1,800	$9,000
Insurance	$780	$807	$836	$865	$895	$4,183
Maintenance	$325	$962	$559	$2,266	$1,332	$5,444
Repairs	$0	$0	$182	$435	$632	$1,249
Total						$47,472

Adapted with data from: Edmunds

 

As shown above, even if we sold the cars after year 5, we would only get half the price tag for them since most depreciation happens in the first few years. The numbers shown in the totals would represent the estimated cost of ownership even after selling the vehicles after the five years.  On top of this, brand new cars end up costing much more in taxes, fees, and insurance than older models.

 

Think five years down the road

Obviously, we cannot simply compare buying brand new cars and investing in the markets. That would leave us on our bicycles. Reaching financial independence is great but we still like our small luxuries.

If we complete the same exercise with the five-years-old models instead, we could then compare the true cost of car ownership. Let’s assume we would buy these models used, the going prices at the moment for a 2012 Honda Civic with reasonable mileage is around $12,000. Right there we are saving $12,530 due to depreciation. In addition, the depreciation hit we would be taking in the following years will be much less since depreciation is much higher in the first years.

A recent Fidelity study showed a drop in the value of nearly 30% in the first year of ownership. It is important to remember that new cars have some advantages too. The maintenance and repair costs are (hopefully) minimal and gradually increase over time. Between the 2^nd and 10^th-year, the cost of maintenance increases by more than 68%. From the 10^th to 15^th-year maintenance costs increases by another 28% on average.

 

Source: Fidelity

 

There is a balance to be found for every model but using our example, a 2012 Civic would eventually depreciate another 50% over the next 5 years but this only represents $6,000. All the other costs, except maintenance and repairs, would also be much lower. The secret is to find the sweet spot for the particular model you are interested in.

This is why we are still driving our old Honda Fit and SUV. Both of them are now 10 years old but have not required any major repairs yet. Our car has required very low maintenance and we have spent roughly $1,000 on it since we bought it 3 years ago and our SUV needed a few parts replacement so we spent around $4,000 on maintenance and repairs in the last 5 years.

We paid cash for them so we do not incur any interest costs and our insurance premiums are kept to a minimum since they are not worth much. Our premiums, for both cars, with both drivers, are only $56 per month.

Depreciation is also minimized and is almost constant year-by-year since we are on the lower end of the depreciation curve. We are only estimating using the going prices online but it is slightly under $1,000 per year per car. To compare, the brand new cars used above depreciated over $15,000 in the first year alone.

Over time, even when we compare with the purchase of lightly used cars, financing two brand new cars adds up to a  total opportunity cost of over a hundred thousand dollars. This is a crucial part of our plan to reach financial independence. Once you tackle these main expenses, the rest is easy.

 

What to look for in a car?

Dream cars are nice and flashy but no one actually needs them. Functionality should trump showy, but you still deserve some comforts.

 

Might be functional but…

 

There is nothing wrong with minivans, some financial independence bloggers like Justin love them but it is just not for us. This only goes to show how important it is to assess your needs. If you have a large family or often have bulk to haul around, then a minivan might make sense. They are much cheaper than SUVs or pickup trucks, offer low ground clearance, sliding doors, fold-flat seating, and get better gas mileage.

1. Are you driving around more than 4 passengers regularly?
2. Do you often haul large bulky items?
3. Will you be towing a trailer or camper?
4. Are looks important to you?

If you answered yes to all of the above, a minivan would be great for you!

For any category of vehicle, there are questions you ought to ask yourself before settling on a model. If you live in a climate where you will end up driving in snowy or icy conditions like us you might prefer a higher ground clearance. The same goes if you prefer sitting upright instead of in a low sports car. If you prefer having 4 doors rather than a Coupe you might consider less sporty models.

There so much variety in the car world that you can find practically anything at your price point. The Kia Soul is a great example if you prefer SUVs but do not want to pay the SUV premium. Other smaller models like the Honda HR-V offer a lot for half the price tag as the full-size Honda Pilot.

The same can be done for cars. Models range from 2-door Smart cars to compact cars like the Civic to mid-size like the Sonata to full-size sedan like the Taurus. From there you can compare brands. We always buy Japanese brands since they are renowned for their reliability but they do come at a slight premium on the used market. American brands can be cheaper to purchase and the parts are slightly cheaper but they have a history of failures.

1. How big do I really need?
2. What build do I prefer?
3. Which model do you prefer?

Once you have asked yourself these three questions, you can start comparing listings online. Both the new and used market are easy to shop and compare through.

 

Let the kids pay for their own college

To wrap this up, we still ought to speak about this famous $100,000 car. We could buy and finance this $58,045 Ford Mustang Shelby GT350 for only $935 per month for 84 months. The opportunity cost of such a car payment would add up to a whopping $102,243 after 7 years. (Assuming 7% returns after inflation)

 

Source: Bankrate

 

There you have it. Skip the monthly payments and save over $100,000 over the next seven years. That is not even counting all the other costs. This is only considering the monthly tie-down of the car payments.

When we talked about money in our last post, we discussed the difficulties when starting to save and invest but all these are deeply rooted in your ability to save. Your savings rate will be the biggest driver of wealth in the early years of your path towards financial freedom. Whichever car you choose to drive, stay within your budget, be aware of compound interest, and make it work for you instead of for the banks.

Cheers, Mrs. and Mr. Xyz.