Let me get something straight before I start. I am not an advocate for buying new cars. However, the reality is that a new car loan is part of everyday life and will people continue to buy new cars, regardless of what I think. Rather than abandoning you altogether, I think I can help.
The process of buying and selling new cars is fairly predictable for the typical consumer. I say that with a grain of salt, because what was typical two years ago may no longer be true after we get out of the recession. It’s quite possible that many more people will be buying used cars, and will be financing for shorter periods of time or paying cash.
I’ll attempt to examine the situation with the best information available. Lagging indicators (perhaps not yet reflecting the effect of the current economy) show the average car loan length to be just over 5 years. 60+ payments is a pretty solid commitment. We’ll also consider the most widely available car warranty length, which is 3 years. Extended warranties of 5 to 10 years are possible, but less common.
With these few assumptions, we can map out the expected financial life of a new car over four distinct stages. Each has unique characteristics and ways to optimize the experience.
Let’s take a look:
Stage 1 – The Honeymoon (Year 0 – Year 3)
As soon as you drive that shiny new car off the lot, you’re in the first stage. Your car expenses are fairly straightforward – a loan payment, high insurance premiums, and gas. Unless you lose your job the day after your purchase, or you were really off on your payment estimates, keeping up financially is comfortable.
If anything goes horribly wrong with the car (mechanically), the warranty will almost certainly cover any repair costs, so worrying about maintenance is not an issue.
The most significant effect of the honeymoon is a huge depreciation of your car’s value. Unless you’re planning to sell immediately, it may only seem like this is a loss on paper. But if you happen to get into an accident and total the car, you may be on the hook for the difference between the street value and your loan. A big down payment and/or gap insurance will help protect you.
If you’re in Stage 1:
- Use predictability to your advantage. If your loan company allows you to, try to pay down your principal early to shave off a lot of interest from the loan. Or, save almost 100% of your extra car money toward repair expenses later on.
- Shop around for car insurance. Your bill will probably be the highest in Stage 1, so it makes sense to optimize it as best as you can.
- Look into gap insurance if your car is worth much less than what you owe. Many dealers offer this as a one-time or monthly payment when you buy, but you can also get it from certain car insurers.
- Don’t skip out on regular maintenance just because you’re under warranty. Cutting corners during the first three years of ownership will bring bad car karma when it comes time to pay the repair bill yourself.
Stage 2 – The Push (Year 3 – Year 5)
You’ve had your car for three years, and the two of you are finally getting comfortable with one another. At month 36, you’ll probably pass that magical mark that sends your baby into the world on her own – your warranty expires.
Usually, this doesn’t mean riches one day and the poorhouse the next. But you need to be careful. Because you’re still making loan payments for the next two years, it’s a difficult proposition to save for potential repairs. If your income has been affected since the loan originated, you may be struggling even more. But repairs are on your dime, so being prepared is better than being sorry.
Equity is slowly starting to stabilize during this period. Drastic declines in value have turned into trickles, and your loan-to-value ratio has become level or even positive as the loan it paid down.
If you’re in Stage 2:
- Start to phase in savings for maintenance. The car has been running smoothly, but even expected repairs like new tires and brakes should start to catch up with you before Year 5.
- Consider an extended warranty. If you’re really strapped for cash and any major problems would be catastrophic to your finances, an extended warranty to get to through this stage may be beneficial. However, it’s just another form of insurance, and you’ll likely lose out money in the end. Do it only if it makes sense for you.
Stage 3 – The Lull (Year 5 – Year 8 )
Finally – making that last car payment feels like victory is yours! It gets even better when the title to the car comes in the mail. After 5 years, the equity locked up in the car is finally yours. You own 100% of it.
With new-found room in your budget, you might be tempted to overspend in other areas. But with discipline, minor maintenance will as affordable as it will be regular (many things will need to be replaced!).
Most people who enter Stage 3 feel like they no longer have a financial obligation to their car. They stop saving because they’re tired of sinking money into something that serves a purely utilitarian function. They’re bordering on mad and resentful.
If you’re in Stage 3:
- Don’t give up on your asset. Not making payments may feel like a huge burden off your shoulders. You feel relieved and you want to forget about it. Don’t fall into the trap of being unprepared for maintenance! Use at least a portion of your old car payment amount and save it for the future.
- Don’t buy a new car. Don’t laugh – you might actually miss your old payment. This new-found room in your budget may have your hands and wallet itching. But the longer you keep your car, the more bang you get for your original buck.
- Negotiate your insurance. Make sure you’re still getting the coverage you need for your car. Perhaps the deductibles can be adjusted, now that cash flow is better?
- Take care of your car’s maintenance and help it last longer. Don’t let little car problems turn into nightmares.
Stage 4 – The Fade (Year 8 – Infinity)
If you get to keep your car past the 8-year mark, you’ll really start reaping the benefits of your original purchase. Your purchase price will be spread over a long period of time, lowering the overall average cost of the vehicle.
As the car ages, major maintenance will become a bigger concern. Things like transmissions, A/C compressors, suspensions, and (may this one never happen to you) – engines, cost a lot of money.
Although buying a new car may still not make financial sense, there are a few situations in which it would be advisable.
If you’re in Stage 4:
- Don’t fall into the trap of buying a new car because of one-time repairs. If you’re saving regularly, you’ll be able to pay for most of them out of pocket. Chances are, your large repair bill is still peanuts compared to a new car payment.
- Monitor the value of your car and cancel your comprehensive/collision insurance when it makes sense. This will bring down your insurance premiums even more!
- Don’t hang on forever. If you need to replace the engine, transmission, and gas tank all in one month, it may be time to throw in the white flag. Consider the importance and value of reliability compared to the money you’re saving by keeping your car.
When you buy used, you typically enter the process somewhere in the second or third stage. Equity will not be an issue because you’re either paying cash or financing on a short-term basis.
Warranties are entirely possible, especially if you purchase from a dealer. And you can take advantage of lower insurance premiums because of the car’s value.
Overall, you’ll bypass a lot of the nastiness of new car buying and jump in at the most advantageous time. The only long-term worry is how well that used car you just bought was taken care of before you got your hands on it.
Getting the Most From This Post
The goal of this post is self-awareness. Once you know where you stand, you can stop feeling sorry for yourself and actually do something productive.
I’ve given you some action items to work with for each stage of your car’s life. Many of you are stuck somewhere in the middle – you have two cars, each at its own point in the time line. You’ll have to find the right balance between the two or treat them as individuals.
Owning a car is one of those things – you know…a necessary evil. You might as well optimize the experience by being smart with your choices!
If this post hit the spot, here are a few more to check out:
Disclosure: This post contains links which represent a financial relationship between this blog and the advertiser.
10 thoughts on “Navigating The 4 Stages of New Car Ownership”
I would toss in one idea – people like me who save money until they have the cash to pay for a new car (which is what my wife and I do). We like new cars, but we never finance – we save until we have enough to pay cash for new cars. We buy with the idea that the car will last approximately 10 years.
I agree with your reasoning otherwise – buying a new car with a loan is a bad idea. Basically what you’re saying is “I can’t afford this car but I still want it.” Nobody should buy anything (except a house) on credit, in my opinion.
Great point, and I commend you for saving up enough cash to be able to purchase a car that way. I would add that it’s hard to get out of the cycle of loan-repay, loan-repay, unless you really make it a goal and focus on saving up extra cash and making sacrifices until that first cash purchase.
Once over that first huddle, it’s easy to keep it going car after car.
The problem lies in the society itself. Advertisements are everywhere to lure people into buying things which they can’t really afford. You look at the pretty adverts for a new car on TV and they say that you really need to own this car. To make things worse, you get credit like crazy even if you’ve got a bad financial history.
Hopefully, a lot of that craziness has subsided. I’ve seen statistics that about 1/3 of recent mortgage applicants were being denied through the initial process. About 40% are actually closing. Most of those who know they can’t afford it don’t even bother applying… Those are all good signs that a little sense (even if it’s a bit too conservative for now) is returning to bankers. We are hurting because of it (lack of credit for individuals and businesses), but I honestly believe it’s part of the rebuilding process.
On the ads issue – marketing gurus are paid a whole lot of money to figure out how to push our buttons. It’s not going to get any easier as we’re hit with more information on a daily basis. While we can do our best to avoid advertising messages, the decision and processing power has to ultimately lay with the consumer. We need to be able to maintain self-control over our money and make the decisions that are best for us.
There are times when taking a loan makes sense in purchasing a new car…the 0% financing. We bought a new car once…1995 at the end of the model year when they were getting rid of them and giving 0% interest for a 2 year payoff (and you had to have good credit for that arrangement). We took that deal, and 14 years later, we still have the car and it runs well. It will be with us until it has no life left in it.
Since then we have purchased only used, from dealers, which come with a warranty. We paid cash for those and they’ve each have made it longer than we expected – one which we still have.
We’ve learned that it really does not make sense to buy new. Not with the glut of good cars available. People buying the new cars and then selling only a few years later are fabulous, stupid, but fabulous. They are eating the price depreciation of those first few years and giving us the bargains.
For most people, a car just needs to provide a reliable/safe means to get from one place to another. Do you get more value out of it because it’s new? Most likely not.
Anyhow, I could go on and on with this topic, but suffice it to say, that there is very little justification from a financial planning perspective to buy new cars.
One piece of advice I’ve often heard is that cars coming off leases are usually well-taken care of and almost like-new. But everyone I’ve known that’s leased a car usually skimped out on good maintenance and taking care of their car. (“Oh, it’s just a lease…”)
Can anyone speak to this and their experience with buying a previously-leased vehicle?
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