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The cost of buying a car can cost upwards of $50,000. Fortunately, it doesn’t have to. A good, reliable car can cost much less, but requires some due diligence.
When deciding between a new and used car the most obvious cost difference is the amount you will pay for the car. There are several other costs between buying a new car or a used car but let’s focus on the base price.
A brand new SUV may range from $30,000 up to over $50,000 (depending on the model). You can easily save over $7,000 by buying a used SUV with less than 10,000 miles on it. $7,000 may not seem like much when you are spending over $35,000 on a car but in the grand scheme it can make a profound impact.
The Cost of a Buying A Car With Cash Upfront
There are two ways to pay for a car. You can either pay for the car in full or make monthly payments with a built in interest rate.
If you pay for the car in full, the $7,000 you could save on buying a used car can make you so much more than the $7,000 you would spend. Assuming you have the additional $7,000 to buy a new car and decide to go with a used car instead, you can start making money on that $7,000 immediately by investing it.
Once you spend the $7,000 it is gone and can never be recuperated. There is significant growth potential on that $7,000, if you decide not to spend that money and invest it instead.
The following chart shows just how much growth potential there is if you invest the $7,000 and earn an average 7% interest over a variety of different time frames.
In just 10 years, the money you would have wasted on a brand new car nearly doubles when you invest it. Investing the extra $7,000 as opposed to spending it is a wise decision, so long as you have the money.
The Cost Of A Buying A Car With A Loan
If you opt for a car loan to pay off the purchase of a new car over 5 years you will lose out on even more money.
Fortunately, most car loans use simple interest not compound interest to calculate the interest on the loan. This means the interest rate will be applied to the principle of the loan at the time of purchase only and not compounded on the interest at certain intervals of time.
Compound interest is great when you’re saving money and simple interest is great when you must take out a loan.
2% simple interest on a
- slightly used SUV that costs $35,000 is $700.
- brand new SUV that cost $42,000 is $840.
This isn’t too bad if you need to take out a loan.
Taking out a car loan for a brand new car that costs $42,000 verses a used car that costs $35,000 can have a significant financial impact. This is especially true if you could have invested the difference of the loan payment.
The monthly payment on a $42,000 loan with 2% interest for 5 years is $713. The monthly payment on a $35,000 loan with a 2% interest over 5 years is $583.
That is a difference of $130 that could be invested monthly over 5 years. $130 invested every month for 5 years with a 7% interest rate could turn into almost $9,000.
Total Cost of Buying New Verses Used With A Loan
When you factor the base cost of the car and the cost of a loan on a used verses new car, the new car will cost you $16,000 more. That’s $7,000 sunk on the price of the car and $9,000 in lost savings/interest.
The potential loss can be eased by putting money down when you purchase the car also known as a down payment. The down payment will lower the amount of interest you will owe. However, it won’t make up for the potential loss in savings/interest if you choose to buy a new car verses used car.
There is real money to be gained by purchasing a slightly used car instead of a new car when your money is fluid.
Side note: If it turns out you can pay off your car loan faster than the term period that is great. Unfortunately, the interest may have already been applied to your account. This is called precomputed interest.
Precomputed interest means you will not save any money in interest by paying it off early. The silver lining though is at least you own your car outright and you don’t have to worry about making your monthly payment on time.
Cash Back Incentives and Interest Rates
There are times where the cost of buying a new car may not be that different than buying a gently used car. Many car dealers have special offers to encourage consumers to buy a brand new car.
Cash Back Incentives
One of these techniques is through cash back incentives. Generally, it works like a coupon and is applied to the final cost negotiated on the car. For example: if you have successfully negotiated the cost of the new car down from $45,000 to $42,000 and there is a $3,000 cash back incentive, then you will only have to pay $39,000.
Cash back incentives are offered by the manufacturer not the dealer. So, while you might be able to get cash back on one car at a dealer not all cars will have the same rebate or any rebate. Rebates are not always advertised so it’s best to ask upfront.
Interest rates on car loans for used cars are often higher than the interest rate you can get on a loan for a new car. This is another marketing tool dealers use to get consumers to buy their new cars.
As noted above, 2% simple interest on a $42,000 brand new car is $840. Assuming 4% simple interest rate on a $35,000 gently used car, you would pay $1,400 in interest.
The Impact Cash Incentives and Interest Rates Can Have On Car Buying
The combination of cash back incentives and low interest rates can add up. The right promotion could get you 0% interest rate and at least $2,500 cash back.
In the above example, that means if you are taking out a 5 year loan, you would only pay $39,500 ($42,000 car – $2,500 cash back + $0 interest) for a brand new car and $36,400 ($35,000 car + $1,400 interest) for a gently used car.
Buying A Car is Ultimately Your Decision
Buying a new car gives many people peace of mind and the premium cost of buying a car brand new is worth it. There is no reason to feel guilty about buying a car brand new if it’s something important that you value. We all have different priorities – know yours.
Whenever possible, it is always best to buy a car outright and not take a loan. Aside from the additional money you’ll have to pay on the loan, the car is not yours unless you can continue to make monthly payments. Nobody wants that debt hanging over their head.
Always try holding off on buying a car until you can pay for it in full. Current car owners should ask themselves how badly they need a new car (whether gently used or brand new).
Waiting a year to save up for the car could help you avoid taking out a loan. Being patient and steadfast for the time will help you save money.
First time car buyers could opt initially for a cheaper used car. Then, they could start saving money for a better used car or brand new car a few years down the road.
The Cost of Buying a Used Car
A car is meant to get you from one place to the next. It shouldn’t be a symbol of who you are or where you come from.
Today, there are many online tools that can be used to support the safety and security of a gently used car. Carfax.com provides free reports on their used cars being sold. The report alerts buyers to any accidents or damage that the car may have experienced, as well as the service history of the car when available.
It’s easier than ever before to know what kind of used car you are buying. So, don’t shy away from buying a used car because you don’t know its history. A little extra homework could save you a lot of money.
Additional Costs to Consider When Buying A Car
There are a few other costs that should be considered when buying a brand new car verses a used car. Depreciation, car insurance and maintenance/repairs can have profound impact on the cost of car ownership. Subscribe here to be notified when the next article comes out that reviews these additional costs.