When Buying a Car, The Total Cost of Ownership is More Important Than Purchase Price
Many car buyers worry most about the purchase price of a new car. Focus instead on the total cost of ownership of the car. This includes all of the costs to own a car for the time period you have it. Total cost of ownership include depreciation, interest, insurance, fuel, maintenance and taxes. Add all of these costs up over the period that you expect to own the car to come up with the true cost to own it.
Did you notice that I did not mention the purchase price? This is not a typo. A car is a depreciating asset, meaning it goes down in value as you own it. The difference in purchase price and sell price will be the depreciation of the car. Lets take a better look at how to estimate this and the other costs of ownership mentioned above.
What Makes Up The Total Cost of Ownership?
The total cost of ownership of a car is the sum of the following costs:
- The Cost of Depreciation
On newer cars, this will be your largest cost. A brand new car will average a loss of 20% of it’s value in the first year! This will be followed by an average of 10% per year until the car is 5 years old. Following the math, buying an new car will average a 48% loss of your purchase price if you own it for 5 years. Not every car has the same depreciation rate, so you would want to check a service like Kelly Blue Book in order find the exact cost on the particular model you are interested in. Also, take note that buying a used car allows your to avoid the worst part of the depreciation curve.
The money you spend at the pump will be greatly impacted by the fuel economy of the vehicle you choose. Large trucks may end up averaging 15 miles per gallon, while smaller hybrids may average times much! Not many people will cross shop an F150 and a Prius, but the fuel economy of comparable vehicles can vary widely. A 4×4 truck based SUV, like a Tahoe, will potentially cost you thousands of dollars to operate more every year than a smaller car based SUV like a Honda Pilot. The more miles you drive, the worse the math gets. Also, pay attention to hybrid and EV cars, as the extra up front cost can often be outweighed by the fuel savings. The EPA has a great tool for researching the expected costs of fuel an comparing it to other cars.
- Cost of Interest
If you are financing the car then you will need to add in the cost of interest for the loan. Certain manufacturers will often offer financing incentives to drive sales on new cars. This can make big difference in how much interest you end up paying can can be as low as 0%. You can ask your lender to give you the total cost of the loan in writing.
The ad valorem taxes you pay are generally tied to the value of the vehicle, meaning the more expensive the car the higher taxes you will pay. You can call your local registration office to ask about the taxes you will pay to title the car, and to renew the car annually. Don’t forget that certain electrical vehicles will still qualify for federal tax credits. This tax credit can be so large that it makes an electric vehicle cost effective against gas powered alternatives.
Never make assumptions about the cost to insure. Always call your insurance company, or an independent broker for quotes. The rates can vary widely based on features of a car that you may not even be aware of. A car’s theft rate, cost to repair accident damage, and other factors can have an impact on the cost to insure.
- Maintenance and Repairs
This one is a bit more tricky to estimate, but can don’t skip over it. In general, cars with bigger engines and larger tires will cost more to maintain. Foreign cars, particularly german cars, are generally dramatically more to maintain and repair than their domestic counterparts. Also, note that though you save money on depreciation buying used, you will spend more money on repairs and maintenance when you do so. This is often why you see German cars depreciate so rapidly, the maintenance expenses to keep them on the road get very expensive.
When you are shopping for a new car, the purchase price is often the easiest number to fixate on. This is a mistake. The purchase price is on indirectly related to the actual cost to own the vehicle. Depreciation, fuel, maintenance, repairs, taxes and insurance will all add up to give you the total cost to own it.
When shopping for a new car, always use the total cost of ownership to compare your choices. Cars are depreciating assets, so pay attention to how much you are really spending to keep from really hurting your personal financial picture..