How much should you spend on a car?
- Don’t have more than 50% of your annual take-home income in stuff with motors
- Never take a finance term for more than 4 years
- Put a 20% deposit down (or as much as you can!)
- The sweet spot is probably 3-4 years old with less than 60,000km on the clock
- Keep your monthly repayment around 1% of your net annual income
- Be really reckless and pay cash for the whole car if you have the money saved
I have a problem
Hi, I’m Glen and I love cars. It’s annoying. If I had the space and the money, I would keep every car I’ve ever owned.
I would buy more cars, even if I only drove it once per year (such as a 1974 Ford Cortina). So as a preface to this post, you need to know that I want you to have the car you love.
If you don’t love cars and just need something decent for your budget, I will help you too.
Some of the most common questions I’m asked:
“how much should I spend on a car?”
“should I buy new or second hand car?”
“Should I get finance from the dealer, a car loan from my bank, a personal loan or take it from my mortgage?”
Sometimes I even get the old-fashioned question of “should I pay with saved cash for a car?” Weird.
Like anything related to personal finance, it’s personal. Like a medical doctor knows, everyone is unique and different. Just call me Dr Glen. Or don’t.
The golden rule - 50% of net annual income
First and foremost, you should not have more than 50% of your net annual income tied up in things that are going down in value (cars!), things with a motor (boat), or toys (motorbike).
For example, if your take home (net) annual income was $60,000 your limit is $30,000. So if you needed to upgrade your car and had a boat and motorbike worth, say $10,000 combined - you would spend a maximum of $20,000 on a car.
This is a good guide and can be used for most situations.
You are also allowed to spend less than this ;) You can actually get good quality second hand cars for under $10k... even some around $7-8k.
No more than a 4 year finance term
Another must when borrowing money for a car is to never take a repayment term over 4 years. I have had friends borrow over 5 to 7 years. This lowers the weekly repayment which you should never look at while at a car yard and will get you into a higher value car which you can’t actually afford. Also, 4 years is a long time in any case. If you’re anything like me, I want another car after 2-3 years as I just want a change. No other reason. If you put 20% down into each car you will be able to chop and change with less issues if you had to.
Unless you are using the vehicle for work purposes and can make a portion of the interest payment tax deductible and depreciate a portion of the capital value, I would not suggest getting a loan or lease scheme with a balloon amount at the end of the term. If you are, the 20% down again will help you at the end of the term.
Let me be very clear. 99% of the time a car will not make you money, unless you are a collector and never drive it. Which is practically no one. Cars are a tool that we use for day-to-day life which decrease in value every single day. The funny thing is, you can’t get too caught up in the new designs as by the time you purchase a new car, I guarantee you the next design is almost ready and you purchased the old style. Eww. Yuk. How could you!!!
I would recommend putting up to 20% of the purchase price down when you take a car loan – of any type. This will ensure that if your circumstances change throughout the loan term and you need to offload the car – you will not owe more than it’s worth. If you were purchasing a $20,000 car, I would suggest saving around $4,000 toward the car. You’ll thank me later. If you can't do 20% please do put some money into it.
The sweet spot - a car that is 3-4 years old
I believe the sweet spot for a car purchase if you are thinking of buying "new", is 3 years old with less than 60,000km’s on the clock. This is how I purchase my cars.
Cars lose up to 60% of their value in the first 4 years. This is actually ever increasing with the rise of Chinese and other Asian cars being imported and selling brand new for cheap with the lure of 7-year warranty. This in turn makes second hand cars so cheap and conversely new cars fall off a price cliff so much sooner. A lot of these warranties are now transferable, so you don’t need to buy new to have this!
Keep your monthly repayment around 1% of your net annual income
This is also a good little guide to keep you safe from harm. If your net annual income was $60,000, you can spend up to $30,000 on a car (not new, but ex demo or up to 3 years old!). 1% of $60,000 is $600. You would your car payments to be around this $600 per month, on a 4 year term, if you borrow money for your car.
If you were to borrow $30,000 the personal loan calculator on nowfinance.com.au tells me the monthly repayment would be $780 (based on a 9.95% interest rate) over 4 years (48 months). Once we apply our savings to meet the 20% rule or $6,000 down on the car, it means a $24,000 loan. The amount for the same term and interest rate reduces to $628 per month. If you take this to $23,000 - you would be under $600 - so maybe negotiate your buy price!
These percentages are guides to keep you in the ball park.
Four popular loan types
Personal loan - a loan given to you with no security behind it. If you can't pay the lender can't repossess anything from you. This will be the highest interest rate as the lender has less chance of getting money back if you can't pay.
Car loan - a loan that has the car as security for the lender. If you can't pay the lender will legally repossess the car back, sell it and any left over monies owing, well they will chase you for it. This has a lower interest rate than a personal loan and some lenders may not want cars older than say 4 years when you apply.
Home mortgage - some people will redraw off their home loan to buy a car. This is the cheapest form of borrowing as the security is an appreciating asset and the borrower is seen to be reliable. If you don't pay, it's simple- the lender will just take your home. If you are doing this, do not just redraw from your existing facility. See if the bank can set up a different mortgage for this - so you can still smash it in less than 4 years as opposed to paying it off over the next 10.
Leases - These are a more complex instrument which can have a lower interest rate than car loans depending on the person who takes out the loan. I.e. if they are a homeowner or not. Hire purchase, novated lease or chattel mortgage are the common types and you should speak to your accountant before committing to these. They are generally more beneficial for a business owner. These leases would have the function for a balloon at the end of the term. I wouldn't suggest more than 25% and my criteria would still apply for these arrangements (term, value, repayments etc).
Why not be reckless?
You could always save cash and buy a car outright. Crazy right? Still use the 50% rule and buying up to 3 years old if you are buying "new".
Some reliable brands that my mechanic swears by
If you want quality and value, head to Japan. Simple as that.
Popular Japanese makes are Toyota, Mazda, Honda, Subaru. If you get one of those makes they have the history and track record to prove themselves and the service costs are not astronomical.
Warnings about luxury vehicles
I write as I sit in a café far from home as my car is at the dealer getting the adaptive cruise control re-calibrated after it was repaired due to me hitting a Wang. Yes, I ran into Mrs Wang in her Range Rover a few months ago.
My current car is a 2013 Lexus (Japanese, owned by Toyota) IS350 Sports Luxury and there is no dealer close to me.
It’s a 1.5 hour drive to the closest dealer so it’s a pain. Getting a luxury car is also a pain as the repairs took almost 9 weeks as they had to get uncommon parts from Japan. I was significantly out of pocket with hiring cars as my insurance company at the time only gave me a hire car for 2 weeks. Further to the annoyance, due to the damage being over $8,000 they had to send an assessor to the repair shop and that almost took 2 weeks alone.
These are the considerations you need to be aware of when wishing to purchase something a little sexier and premium. Anyway, the only good thing is I get a brand-new Lexus loan car while they service mine! But I did pay for that, as the basic service cost me $727. Never again! It was due for a service and I thought it would be convenient while it was getting worked on anyway.
I’m pretty sure loaning people their brand new model is a strategy to make one want to upgrade.
My final comments on the luxury factor: I did my research significantly before my purchase. I was looking for about 12 months. I wanted a 6 cylinder rear wheel drive luxury vehicle. I got far more bang for buck ($20,000 savings in comparison) buying the Lexus (Japanese) over the equivalent BMW & Mercedes Benz. I didn't bother looking at Audi as they depreciate way too fast. I was almost going to get the Volvo S60 Polestar but I was also a little gun shy with the depreciation factor of Volvos. But then again - all cars go down in value!
When I purchased my Lexus the exact same car brand new was $95,000. I got it three years old, ex demo, with only 11,000 on the clock for $54,000. It also has warranty until September 2018. I was very happy with this purchase. So much that I didn't actually test drive it!
A real case!
My final thoughts & the usual emotional garbage
The most common thing I hear from every second person who wants to get a brand new car is about safety. You can get a really safe 10 year old car. The reason this logic is garbage is because it means a car that is 3 years old is not safe and it must be brand new to be safe. If this is the case and you use this to justify your want for a brand new car to make yourself feel good - you would have to buy a new car every single year to maintain your stance. Now that's not going to happen, is it! Get a 3 year old car, save thousands of dollars and get on with your life.
Other emotional garbage I hear to justify stupidity, I mean, the purchase of a brand new car is the "warranty". Warranties are transferable. Also, I generally service my cars at the local mechanic and this does not void warranty. I have had a warranty issue with a steering rack on my Ford Focus, which I purchased second hand, and Ford still fixed it even though it was never serviced by them. Plus, at least if you buy something a year old most of the time anything that's going to break would probably already have broken.
As a final guide, it's probably OK to buy a brand new car if you have a net worth of over $1m, as you can afford to take the financial hit. I would still use my 50% rule (value) 1% rule (repayment) and 20% rule (deposit).
Finally, always remember that new car smell is the delicious toxins leaving the plastics :)