Ten years ago the proud new owner of a Honda Civic brought his car home from the dealer. Days later he totaled it. It was salvaged, went through a few owners, and is now my wife’s primary mode of transportation.
After several years with the Civic it is time for my wife to upgrade. Over the last few weeks she has been shopping, test driving, pricing, and looking for financing. I’ve been helping.
Today she test drove a Toyota Camry. She likes the quietness.
New Versus Used: The Conventional Wisdom
This week we are facing the “new versus used” question. The conventional wisdom says new cars lose a significant amount of their value when you drive off the lot.
On the other hand, we regularly see used Camrys for sale at prices not much lower than their new price. For example, I saw a used Camry with 8000 miles for sale at 10% below its new price. We regularly see Camrys with around 30,000 miles for sale at 25% off their new price.
The Camry just doesn’t seem to lose much of its value when driven off the lot. I’m working under the assumption that the conventional wisdom doesn’t apply to the Camry.
Since I don’t have the conventional wisdom to guide my thinking, how do I know whether to buy new or used? I use math.
The Two Candidates
We have identified two cars that seem like good candidates. One is new and the other used. They have similar features and upgrades.
The new car costs $5000 more than the used car. If we buy the used car we plan to get financing through a credit union at 6%. If we buy the new car we can get financing through the dealer at 4.9% or less.
The new car costs $5000 more but has three advantages:
- The car is new.
- It has the full original warranty.
- We obtain financing at a lower interest rate.
The full warranty has some value, but for simplicity I’m going to ignore it.
How Do I Know Which is the Best Deal?
Without doing some math I am faced with a tough question:
Am I willing to spend $5000 extra to get a new car and a better interest rate?
It’s hard to say. I have an intuitive feel for how much more a new car should cost. But without doing some math I don’t have a sense for how much I’ll save with the lower interest rate.
A few years ago I wrote a spreadsheet to help me figure out how much house I could afford. Over the years the spreadsheet has convinced several friends that they could afford a house.
The spreadsheet works for cars as well as houses. By plugging in the numbers for each car I was able to determine how much more the new car really costs after accounting for the lower interest rate. I won’t bore you with the details here. After applying an appropriate discount rate, I determined that the new car would cost $4200 (in present value dollars) more than the used car.
Now the question is easier:
Am I willing to spend $4200 extra to get a new car?
Remember, the original question was:
Am I willing to spend $5000 extra to get a new car and a better interest rate?
The easier question is, well, easier. There is one less variable involved.
Where Are We Now?
My wife and I haven’t answered the question yet. There are still things to think about. We have to think about how much the warranty is worth. We have to think about how much each car might be worth when we sell it down the road and how much of the $4200 we’ll be able to recover. We have to think about how car payments will fit into our cash flow needs over the next several years.
I’m glad we were able to do some math and answer the interest rate question. It makes answering the rest of the questions a little easier.
Postscripts
P.S. The new car is a 2008 model. It is the dealer’s last 2008 left on the lot. He’s trying to get rid of it to make room for the 2009 models. Let me repeat. He has ONE 2008 LEFT! It’s only March 2008! I’m getting the car industry a calendar for Christmas.
P.P.S. My wife has never left a comment on my blog. I suspect she will have something to say about this post since she has done most of the legwork on finding a car. If she leaves a comment it might not be about numbers or finance. It might be something about her doing most of the legwork on finding a car. Sorry honey, I’m really busy at work! Honest!
P.P.P.S. “Quietness” is a word.
The new-car warranty may not be worth much considering Toyota’s history of reliability.
That’s fine Jeff if you want to be so hands off and let me do all the leg work. Just don’t be suprised when you come home to find me out front in my daisy dukes polishing up a new Lexus.
About 10 years ago a wrote a book called “Everybody Drives a Used Car”. I am in the process of updating it. In the process I found this website. http://www.unitusccu.com/vcapps/leaseloan.html
You can use this calculator to compare your alternates.
You also might want to take a look at Chapter #7 of my book @ http://docs.google.com/View?docid=ddxsp7t5_1g2xwf429