The automobile gives rise to intense passions in both sexes. Just a few decades ago car dealerships were places where women dared not go leaving the complex negotiations for a new car to their husbands, brothers and uncles. Upside down on my car was a phrase entrenched in the American lexicon long before the current economic meltdown turned upside down on my house into the catch phrase for the decade. Automobiles are expensive, yet they are the biggest waste of money imaginable and owning a vehicle defies every law of basic financial common sense there is. There are 6 common money mistakes most people make when purchasing a car
1) Putting money down on a new car
2) Leasing a car
3) Trading in a car
4) Buying a new car every 3-5 years
5) Rolling old car debt into a new car purchase
Putting Money Down on a New Car
The author of a well-read and well-circulated financial blog, the Simple Dollar, wrote that you should put money down on a car in order to avoid GAP insurance. What is GAP insurance? GAP insurance stands for Guaranteed Auto Protection and is a supplemental form of auto insurance that covers the GAP between the residual value on the car if it is totaled out and the loan amount on the car. GAP insurance is an additional expense especially if you purchase a car that does not hold its value over the long run (as most dont) but is it worth giving up $3000-5000 cash to avoid the premium? Of course not. And heres why. Cars are depreciating assets. As a rule of thumb they lose 10-25% of their value each year for the first 3 years. Putting any money down on a car, therefore, is a lot like taking a roll of Benjamins into your bathroom, lifting the lid and flushing 30 to 50 of those bills down the toilet. Any money that a new car purchaser puts down will not translate into equity in that car, but will disappear into thin air the moment the new owner drives that car off the lot. GAP insurance on the other hand is a relatively small expense a consumer may or may not choose to assume. Should the consumer choose to get GAP insurance, it is based on the value of the new car and the expected depreciation. For the top-ranked cars in terms of the least depreciation, GAP insurance will cost the least. For the cars that depreciate the most, GAP insurance will cost the most. Kelly Blue book posts an annual list of cars that depreciate the least. Doesnt car insurance offer full coverage for a car? No it doesnt. Insurance companies are smart, they wont pay more than a vehicle is worth. Consumers do that. Car insurance will only cover the residual value of a car in the event of an accident, not the full loan amount owed on a car. Pay $20,000 for a new car and wreck it in the first year, your auto insurance will cover only the residual value of that car. If that residual value is $15,000 and you owe say $18,000 you are on the hook for the $3,000. Here are the basic things you can do to avoid this depreciation calamity and hang onto your money:
1) Only buy new cars that retain their value and negotiate the best deal you can
2) Only buy used cars (someone else has paid for the depreciation)
3) Save like a fiend so that you can self insure, ie., cover the GAP in the event of an accident
4) If you dont do 1,2 or 3 buy GAP insurance because it is miniscule compared to the out of pocket costs of a down payment
5) Dont let your kids drive your car
Leasing a Car
The reason a car leases monthly payment is so much less than the principal and interest payments on a car note is that the lessee is not amortizing the value of the car with the payment. The lessee is amortizing only the depreciation costs and paying interest to do so! As an example if the 3-year depreciation expense on a car $20,000 car is $10,000, the monthly payment on the lease is based on that 10K along with the interest rate. Sounds like a good deal, I suppose, until you figure in that the car dealer will get back a used car at the end of the lease that he intends to sell for the full value of its make and model. What this means is pristine physical condition and low mileage. If the car returns in anything other than perfect condition, the lessee will have to pay in the form of stiff mileage and wear and tear penalties. Lease a car back to back and you loose big time because you are always bearing the cost of someone elses depreciation.
Trading a Car
Basically my philosophy is that you buy the most reliable and high value car that you can, negotiate the best price that you can, pay it off and drive that vehicle for at least 10 years. Even if your vehicle is in pristine condition at the end of 5 years and you just have to have a new one, the dealer will give you at best 50 to 75% of the residual value of your car. The car dealer will make money twice: once on the new car you just bought and again on your trade in when they re-sell it for maximum retail value. It is great to give money away, but give it away to a charity and take the tax deduction. Your car dealer does not need your charity. Here are basic things you can do when you have a car to trade in:
1) Sell the car on Craigs list or advertise it in the newspaper getting the best deal you can for your car. Then you are free to use the money anyway you choose.
2) Sell the car back to a same brand dealer. Ive done it. It works.
Buying a new car every 3-5 years
Buying a new car every 3-5 years means that you are always locked into a principal and interest payment on something that is always losing value. The only way to win with a car is during the years in which you are essentially driving that car for free. At the very least, you can spend your time paying yourself the principal and interest payments, it is a form of forced savings in which you can set yourself up to pay cash for your next car, or use the money to take that vacation you have always wanted to.