It’s always nice to look at the actual math when considering things like should I buy a used car or a new one.

Real Cost

We all have heard that it is far more economical to buy a used car than a used one, and I agree. But let’s look at exactly why.

Estimates are that the average American car depreciates 20% in its first year and 15% per year after that until after 10 years it is worth about 10% of its original value. That is crazy. We tend to pay too much for many years for something that depreciates so quickly. I feel we need to sober up and look at this rationally. I have read many times that the sweet spot in affordability tends to be about three years.

Lets look at the math:

If a car therefore is worth about 57% of its value after three years a $35,000 car will be worth $20230.

Now if you finance this car when it is new:

Price: $35000

Interest Rate: 6%

Term: 60 months

Payment Every Month

$676.65

Total of 60 Payments

$40,598.88

Total Interest

$5,598.88

So by the time you are finished paying for the car you have paid over $40,000 for it. And it is now worth $14616.18.

This seems like a no-brainer. Why on earth would you buy a new car?

I know, I know, you buy it for the warranty. But there is very rarely anything that goes wrong with a car in the first three years anyways:

Popular Mechanics did a study where they tabulated the average maintenance costs for various vehicles over the life of the car.

Interestingly, the first 25,000 miles typically costs $1400 in maintenance. Since Americans now drive an average of 13,476 miles per year, that is only $1400 for the first two years of ownership. Is that worth the price of a new car vs. a used car?

The study continues to sate that costs rise a little each year up to 100,000 miles, with the last 25000 costing on average $3900. After that, they found the costs go up very little for the next 100,000 miles. From 175,000-200,000 miles the average maintenance costs are only $5000.

Most Americans drive a car up to around 100,000 miles then get rid of it. The statistics show that we could probably very safely drive a car twice that long before it gave us any significant problems. Cars are expensive. Why buy a new one if you don’t need to?

From this we can assume that paying an extra $20,000 for a warranty that might cover an average of maybe $2000 worth of repairs/maintenance is not a good deal.

Often times, new cars come with a 5-year warranty so you might still enjoy two years of the original warranty when you choose to get the three year old model anyways.

Prestige?

OK, if looking like a big shot is worth an extra $20,000 to you, then I say, “go for it”. If buying a car is a small percentage of your net worth then ignore this advice and spring for the Ferrari.

But if you are like me and a car is still considered a significant purchase, then maybe a little math goes a long way. Putting myself in extra debt I don't need is something I would like to avoid if I can.

Financing

If you save up that $676 a month for 2 1/2 years you can buy a three year old vehicle for CASH and still enjoy a decade or more of a pretty decent vehicle. Financing a used car usually results in a higher interest rate from the banks. If you need car right now, then I guess you have no choice, but if you can, use a line of credit as you will get a much better interest rate than from the bank.

So the best scenario I can see is to buy a three year old used car for cash and invest the extra money you would have spent.

The financial gurus were right!