Exploring the True Cost of Buying a New Car

There’s nothing quite like the thrill of buying a new car.  The fresh smell of the interior, the new paint job, the shiny chrome wheels and the humming of the engine.  It’s truly a delightful experience.  Unfortunately, it’s a rather fleeting experience.  The car quickly loses its fresh smell and the new paint is replaced with scratches and dents.  Eventually, the shiny new car becomes an old car.  It’s a never ending cycle of selling the old car and replacing it with a new one.

Have you ever considered the true cost of buying a new car?  Let’s examine the financial facts.   You may discover that the “thrill” of owning a new car is not worth the price.      

Many people are surprised to discover that the percentage of successful millionaires who drive a new car is actually quite low.  People who become millionaires have an innate ability to profitably manage their finances and investments.  They’re always searching for ways to save money.  These financial elites are choosing to buy a used car versus a new one because they know that purchasing a new vehicle is not a wise investment.       

Unfortunately, consumers make the mistake of believing that purchasing a new vehicle is an investment.  This is completely untrue.  By its very nature, an investment is designed to increase in value over a sustainable period of time.  This certainly does not describe the buying  of a new car.  In fact, a new car begins to lose value immediately upon purchase.  The average new car declines by 25% as soon as it leaves the dealership.  The majority of this price depreciation is from the 14% VAT, which is payable on all new vehicles.

Although each model is different, the average price decline for a new car at the end of three years is 40%.  This explains why people who are successful with money never buy a new car.  They can buy a three-year-old car at a 40% discount.  

Purchasing a new vehicle is even worse for those who obtain a loan.  In fact, many consumers will finance their vehicle with a long-term loan of 60 to 72 months.  This is a very poor financial decision because the consumer is making monthly payments on a depreciating asset.  The loan accrues interest while the vehicle declines in value.  For example, let’s assume you purchased a Volkswagen Golf 7 for R290 000.  The average interest rate for a car loan is prime plus 1.5%.  The current prime interest rate in South Africa is 10.25%.  Therefore, the interest rate on the car loan is 11.75%.  If the term of the loan is 72 months, the total interest paid over the life of the loan will be R115 975.  Including interest and all fees, the cost of your new car will be 

R412 097.  This represents an increase of 42% above the original purchase price.  As you can see, securing a loan to buy a new car is incredibly expensive and a complete waste of money.          

Car Buying Myths

The automobile industry is filled with false information concerning the purchase of a new vehicle.  This erroneous information is used by consumers to justify their purchase decision.  

Let’s review a few of the most common car buying myths.

Myth #1  My new car includes a free maintenance plan

Many car dealerships promote their new vehicles by advertising a “free” maintenance plan over the life of the vehicle.  On the surface, this sounds like a good reason to buy a new car.  However, these maintenance plans are factored into the price of the car.  Therefore, you’re paying for the plan up front when you purchase the vehicle.  There is no such thing as a free maintenance plan or service plan in the automobile industry.  Don’t be fooled by this “sales pitch.”

Myth #2  I need to sell my car at the end of four years because of rapid depreciation         

This is not a true statement because the rate of depreciation is different for all vehicles.  The rate of devaluation depends on several different factors.  These factors include: the mileage, the condition of the car, the make and model, the strength of the vehicle’s demand in the second-hand market and the relative price of a new car.  Additionally, the majority of the vehicle’s devaluation occurs during the first four years of ownership.  The devaluation actually begins to decelerate after four years.  Therefore, if the car is still in good working condition, there is no need to sell after four years.      

Myth #3  The dealership will offer to finance my new car below the prime interest rate

Actually, this is a true statement.  Occasionally, dealerships will finance a new car below the prime rate.  However, the dealership simply uses the manufacturer’s rebate to finance the vehicle.  You’re actually losing money if you finance the car through the dealership.  Why?  Because you’re missing out on the rebate.  In the long run, it’s much cheaper to pay cash for the car and collect the manufacturer’s rebate.  In addition to collecting the rebate, the dealer will probably offer to sell the car at a lower price if you pay cash.  If you can’t afford to pay cash, it would be less expensive to finance the car through a bank.  The bank can pay cash to the dealership and you can collect the manufacturer’s rebate.  

Myth #4  It’s very risky to buy a second-hand car

Thirty years ago, it probably was a bad idea to make a purchase from a shady used car dealer.  However, these days things are much different in the used car industry.  There are many authorized pre-owned dealers who offer certified second-hand cars.  The majority of these cars have all of the maintenance records from the previous owner.  Many of the cars are still under warranty.  Therefore, purchasing a second-hand car can turn out to be a very good financial decision.  

Myth #5  Banks won’t provide financing for a second-hand car    

If your second-hand car is less than ten years old, banks will gladly finance the car.  The only stipulation is the vehicle must have a clean title and not involved in a major accident.  Additionally, most banks will only provide financing if the vehicle was purchased from a certified second-hand dealer with a good reputation.  If you are purchasing the car from an individual, banks will finance the car if all of the proper documents are included.    

Keep Your Car for Ten Years

If you purchased a new car, you should keep the car as long as possible in order to recapture a portion of the depreciation during the first few years of the vehicle’s existence.  As an added bonus, keeping the car for several years will give you the opportunity to save money for your next vehicle purchase.  

As an example, let’s use the vehicle we discussed in our previous illustration, the Volkswagen Golf 7.  We will assume that your current vehicle is five years old.  Instead of keeping the car for another five years, you decide to purchase a new Golf 7 with a finance plan of five years.  The purchase price is R290 000 with an interest rate of 11.75%.  At the end of five years, the total interest cost is R95 250.  The annual interest cost is R19 050.  

What if you decided to keep your current vehicle for an additional five years?  You would save R95 250 by avoiding the interest cost on the car loan.  You could actually save even more money.  For instance, you could invest the annual cost of interest (R19 050) in a fixed deposit at your local bank.  Several banks are offering 7.85% on a fixed deposit for 12 months.  If you invested R19 050 each year for the next five years, you would have a total balance of R111 424.

You could use this money to buy an excellent second-hand car.  Actually, you could buy a new vehicle with the money from your bank savings account.  Please review a list of the ten cheapest cars in South Africa.      

Ten Cheapest Cars in South Africa

As you can see, it’s much better to drive your vehicle as long as possible.  In the long run, you will save a tremendous amount of money.  

Leasing Versus Buying 

Leasing a car versus buying a car does have its advantages.  However, leasing a vehicle is not a good decision for some people.  It depends on how frequently you drive the vehicle along with your ability to maintain the vehicle.  All lease agreements have a specific mileage limitation.  If you exceed the limitation, you will be charged additional fees.  In addition to mileage limitations, the leasing company will charge fees if you exceed the normal “wear and tear” on a vehicle.  For example, if your vehicle has several scratches and dents at the end of the lease agreement, you are required to pay for the repair costs.  Let’s review a few of the advantages and disadvantages of leasing a car.

Advantages of Leasing    

• The monthly payment on a lease is usually significantly less than financing a new car
• The savings on a monthly lease can be invested in an interest bearing account
• There is no resale risk at the end of the lease; you can simply return the vehicle
• You have the opportunity to drive a new vehicle more frequently 
• Leasing may provide tax benefits if you use the car for business purposes

Disadvantages of Leasing

• If you exceed the mileage limitation, charges will apply (usually R2 – R8 per kilometer)
• Leasing a vehicle means you always have a car payment
• You will pay additional fees if the car exceeds normal wear and tear 
• Attempting to cancel the lease prior to the expiration date can be very expensive
• You don’t own the vehicle at the end of the lease

Review all of your Options

Buying a car is a very important decision.  It should not be taken lightly.  You should definitely review all of the advantages and disadvantages of owning a new vehicle.  Next to the purchase of a home, buying a car is probably the second most expensive item you will ever acquire.  Therefore, you should approach this decision with a great deal of thought and reflection.