Monday, November 17, 2014

New Car Math

The other day the manufacturer of my newest car sent me a rather complicated questionnaire. This survey was attempting to determine what motivated me to buy a particular car. I was given a long list of factors, some redundant. These included, value, gas mileage, reliability, long life, safety, fun to drive, stylish, and environmental impact. Once the respondent selected and ranked seven items from this list, another list of questions was generate to determine how you ranked your seven factors relative to each other by numerical score.

Surveys of this sort are scientific instruments designed by psychologists and sociologists. The information they provide is factored into what products are produced and how they are then marketed to the public. However this one didn’t capture the process I use to buy a car.

After housing, cars are typically a family’s largest expense over the course of a lifetime. The current average cost of a new vehicle is $32,086. That would be a monthly payment of $641 according to the Motley Fool. The bottom line is the average American can not afford to buy an average new car. suggests the “20/4/10” rule of thumb for determining if a car is affordable.

A down payment of 20%, say $6,400 just for grins.

The four is a maximum loan duration of 4 years

This would generate a monthly payment of $560 at 2.24% (If you could get it 3.9% is more realistic) add $100 a month for insurance for a total monthly cost of $660.

In order to meet the 10% part of the rule of thumb your gross household income would need to be in excess of $6,600 a month. That would be a gross annual income of $79,200.

The only problem with this example is the assumption that the family will only have the one car. Most families have two cars. How many households have a combined annual income of $158,400?

Another common rule of thumb suggests that a family can afford a car that costs 1/3 of their gross annual salary. For a household earning around $50,000 a year, that would be a maximum of around $17,000 for a car.

I have a better suggestion. Buy used. Pay cash. If you graph the average cost of a particular model by age or mileage, you will discover a parabolic curve that decreases significantly over the first four years of an automobile’s life the flattens out into nearly a straight line as it passes the ten year mark. You will see an inflexion point somewhere around three to five years depending on the make and model. That is the point of maximum value.

But you already knew that. Late model used cars are a better buy than new cars.

Let’s look at the down payment in the new car example. If you can come up with $6,400 in cash, what can you buy? A quick look at the Carmax website showed a 2006 Hyundai Elantra GLS four door sedan at $7,000. This car would probably serve a young family of four for at least six or seven years. If the family saved $600 a month for their next car instead of giving the money to the bank, after six years they would have $43,200 in cash at 0% interest.

What kind of car can you buy for $43,200? How about a 2014 Lexus GS 350 at $44,000?

Now we’re talking new car math.

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