Every once in a while I get asked “do you think I can afford XXX?” and I think to myself this must be what it’s like to be Suze Orman. Since I’m throwing out rules of thumb, let’s get to cars. This will be a controversial one, but I like it and following it has worked out well for me.
Car Affordability Rule of Thumb
You can afford a car if you can pay CASH for it while still making timely progress on your other goals. I repeat: If you can’t pay cash for it, you can’t afford it. By cash I don’t mean retirement savings in an IRA, I’m talking about actual cash in the bank (or at least something you could quickly sell for cash in the bank).
If you have to justify it with “I’m in medical/law/computer/finance/basketweaving school and I’ll be making the bucks soon!”… no you still can’t afford it. If you justify it with “I need a brand new car because I need something reliable and anything less will explode! Do you want me to die???”… no you still can’t afford it.
First, I’ve probably mentioned before that I appreciate cars. I still have Car and Driver magazines from 20 years ago. I wanted to become an ASE-certified mechanic for a while and even applied to automotive school, but settled on being a mechanical engineering major. But as someone who also values financial freedom, I also know that cars are the biggest area where the price paid vs. utility derived (i.e. value) can get completely out of whack. While a BMW M3 is a beautiful example of precision German engineering, unless your commute involves a German autobahn it won’t get you to work any faster than my 2001 Pontiac.
I’m also a proponent of individual choice according to personal priorities. I don’t think everyone who owns a Jaguar or Porsche is stupid. I think great cars are awesome, just like I think great buildings and great bridges are awesome. (Top Gear reference!) You may derive an obscene amount of personal joy out of owning and working on your car. But if you want to make a financially-smart decision, buy it with cash saved up after you put 15%+ of your pay aside for retirement.
What if I only have 50 bucks and need a car for work? Well, my first advice would be to try harder to find alternatives. Public transportation may be uncool, but so is being flat broke so I’d just get over it. Can you get a ride from someone, or carpool with a co-worker? Could you (gasp) bike or walk? If you absolutely have to finance a car, buy used and get a loan from a respectable place like PenFed which offers used car loans starting at 1.74% APR. Which brings me to…
Reliable car sweet spot? The “true cost” of a car is the sum of depreciation loss, maintenance costs, gas, and insurance. New cars hurt you on the depreciation front. Going too cheap may result in high maintenance costs overwhelming the low depreciation. Reasonable people can disagree on the exact number, but in my opinion you can minimize your “true cost” by buying a reasonably reliable car for about $4,000-$5,000. At this price, you can get a 10-year-old Civic or Corolla with around 100,000 miles and it will very likely run fine for many years if it was properly maintained. I personally like the idea of a more recent 2005+ GM or Ford with lower miles as Hondas and Toyota are currently fetching quite a premium. If you are especially knowledgable about cars and know what to look for, you could probably spend $2,000 and get a reliable ride.
I’m not saying everyone should drive a Corolla. But if you have to take on debt, I don’t think you need to spend more than $5,000. If you want something nicer, that’s what savings accounts are for.
Buying new. I’m fine with buying new if you have the cash. My parents are the buy-new-and-drive-til-dead type, and they’ve done well with that philosophy.
Financing or leasing. I said CAN pay cash for it, not that you necessarily have to pay cash for it. If you find a great 0% APR financing deal then go for it, but know that you can often exchange the 0% deal for a lower price. Leasing is usually forbidden in frugal circles, but in my view leasing is the same as buying new and agreeing to sell your car later at a predetermined price in the future. You can still negotiate a lease. If you have the cash, want a new car every 3 years, and hate dealing with repairs and selling cars, then there is a chance that leasing will work best for you.
Again, this rule of thumb won’t apply to everyone, but I think it’s a great rough guide to help those with growing salaries to manage lifestyle inflation. If you want a $40,000 luxury vehicle, you’ll have to plan ahead and save for it. When you’re staring at a nice $40,000 balance on your bank statement, it becomes much easier to weigh clearly the value of the car vs. your money.
As a final note, I hate “affordability calculators” based on monthly payments – that’s the same logic that encourages just making the minimum payment on credit card debt and spawned rent-to-own furniture! Save up and buy whatever car you want, but don’t fool yourself into believing you can afford a car just because the monthly lease payment seems manageable. In general, I think people spend way too much of their incomes on cars when they could have a paid-off mortgage instead.