Wednesday, January 25, 2012

The New Car Trap

Any idiot can buy a new car - even with bad credit, no credit, or whatever.  It takes no talent to pick out a car, write a check, and sign up for the worst financial deal of a lifetime.  And yet many folks act like buying a car is some sort of personal accomplishment.  It is no more of an accomplishment than excretion.  But then again, we teach children in this country that excretion is a major accomplishment that should be rewarded, so go figure.

Another example of faux financial acumen that you will see a lot in the media and online is the "tips to be a savvy car shopper!" kind of article, which touts to teach you all the tricks to "beating the salesman at his own game!" or how to "get the best bargains when buying a new car!"

You read the article and there is no "there" there - just a bunch of platitudes about how exciting and fun it is to buy a new car, and how you should negotiate on price and "get a good deal!".  But trying to "negotiate" with a salesman is merely playing their game - which you will lose.  Your only option is to not play at all. 

It is like those stupid articles about "tips to win big at the casinos!" - you can't win, period.  Just don't go.

Why is buying a brand-new car such a raw deal?  Several reasons.  And many young people buy a brand-new car in their 20's, and live to regret it - if they realize what they have done.   Others continue to buy new cars, convinced that it is "fun" and "cool" to have a new car every few years.  Such folks are not terribly bright - the sort of folks who find Jet-Skiing to be hours of entertainment.

There is nothing special or unique about owning a brand-new car.  They come off the assembly line every few seconds in this country.  Yet many folks consider it a sign of status or class to be able to buy a brand-new car, rather than a used one - even when the car in question is some cheaply made economy model.

In fact, most new cars sold are very inexpensive models, and young people are often targeted as the market for such cars.  Toyota came up with a whole brand - Scion - to market to young people.  Many older people end up buying the cars, of course, proving the old adage true - "You can sell a young man's car to an older man, but not an older man's car to a younger man."

Young people want things - they are starting out in life, and everything seems exciting and new.  Moreover, they are coming from an environment where it seems everyone (adults) have lots of nice "stuff" but they are constantly denied all the things they want in life.  They graduate from college, get a job that pays what seems like a lot of money, and suddenly, they can choose to have whatever they want.

And often, they choose to have everything they want, and end up spending a decade or two bailing themselves out of a debt crises that started in their 20's but did not metastasize until well into their 30's.  Or, as in my case, I went on to make more and more money over time, but by age 30, I literally had nothing to show for all the labor of my 20's, other than some student loan bills.  Imagine that, working an entire decade and not even being able to save $500 in the bank!  And yet my experience is typical, not an anomaly.

The scenario usually plays out as follows.  John is a composite of a number of young people I know, including myself.

James is 23years old, recently graduated from college and has landed an entry-level job with a company.  He is making pretty good money, or so he thinks, as his only comparison is the money he was making in high school.  He can afford an apartment - or to share an apartment with friends - and has the usual collection of toys, such as cell phones, cable TV, video games, computers and the like.  He and his friends spend their non-working, non-sleeping hours figuring out ways to have fun and spend money - usually going to bars or "hanging out" and drinking beer, or going to the mall and spending money, usually with credit cards.

James has the same car he had in college - his Mother's old Honda - which is now many years old and the butt of jokes by his buddies.  He tried "modding" it with some bolt-on accessories, like a cone filter and a "fart muffler", but all they did was make the car loud and annoying.  All his buddies, it seemed, had "nice rides" and James wanted one, too.

On the way by the car dealer, he spies a small fastback coupe that looks sporty.  It was designed with James in mind - it is small and looks sporty, but is really just another economy car with sporty sheet metal work.  James assumes he "can't afford it" and he is right.  But one day, he stops by and looks at it, and the sticker price of "only" $18,000 seems pretty reasonable.  A salesman sees him eyeing the car and steps up to talk to him.

James is no fool - he won't fall prey to a new car salesman!  But the salesman sizes James up and says, "I can show you how you can AFFORD this car!".  Intrigued, James goes along with it, figuring there is no harm in finding out what the "numbers" will be.

And here, the salesman snookers James using a panoply of techniques.   First, he runs James' credit, while they are talking and looking at cars.  He distracts James by showing him other cars or just makes him wait in the waiting room.  The more James waits, the more he has "invested" in the process and the longer he will wait.  James will be there for about 5-6 hours.

The salesman quickly figures out how much he can charge James for a car, based on James' income and credit rating  - and sets out to sell him the least amount of car for the most money.  Perhaps he will first tell James that the small coupe in "GT" trim is out of his price range - but that the stripped down "SE" model (which is assures, is really the same car and a better bargain) is.  Or, if James is making good money, he may try to "upsell" him into a larger or more expensive car.  But since James is young and dumb, the best bet is to sell him the Sally Stripper at the GT price.

Next, is the trade-in.  James' clapped-out Honda with the cone filter and coffee-can muffler is worth little, but the salesman knows that James will be upset unless he "gets good money for it" - so the salesman offers him a hefty price in trade-in - more than James would get for selling it outright.  The car will be sold at auction for $200, so the excess trade-in price is folded into the new car.

Financing is next.   The salesman will recommend a five- to seven-year loan, so that the monthly payments, even at an astronomical interest rate, will be "affordable".  Since James has no good credit, he will easily pay in the double-digits for the loan interest rate.  James does not qualify for so-called "0% financing" or low-interest financing - few people do, actually.

If necessary, the salesman will pitch leasing as the solution - to keep the monthly payment down and to allow him to pad more price into the car.  James may fall for this, as it gets him the car to drive home, but within a payment plan that he thinks he can "afford".  Yes, James is at that point in life where he looks at money as something he gets every two weeks - and spends as quickly.  A few hundred bucks a month sounds "affordable" - but the overall cost of the transaction is never considered.

Leasing has an added bonus for the car dealer and manufacturer in that it forces the buyer to come back in 3-5 years to turn in the car, which becomes and opportunity to lease them a new one - creating a perpetual new-car buyer for the company - at least for a few years, until the cost of this is felt and the customer goes bust or figures out they have been had.

James signs onto this onerous deal, buying the car, sold on 72 monthly payments.  The salesman of course, will throw in the "closing" bits - the rust-proofing and undercoating, selling James the floor mats that came with the car, or paint sealer, or extended warranty, or whatever.  If James is particularly foolish, he will sign up for these add-ons.  At this point, James has no idea what he paid for the car, and chances are, it is close to - or indeed, over - the sticker price.

But, it is nearly 10:00 at night, and James drives home with the new car, with temp tags on it.  He is proud to show it off to his buddies, who mostly say nice things about it, except for his one snarky friend who says, "Whoa, dude, why didn't ya buy the GT model?  The SE is lame!"

But James takes the slight in stride.  He is an adult now - able to buy a new car, with his own money!  This car is a sign of his success and wealth.  And it has cool features, like a remote hatch release, a CD player with speakers that light up!  And cruise control and a working air conditioner!

The next day, he is excited to drive his new car to work, and is convinced that everyone is looking at him in his new car.   If he is particularly tacky, he leaves the window sticker on for a few days, so everyone will know he has a "new car".  But in traffic, he is cut off by another young man in the GT model, and James wonders how that fellow could afford the upgraded version (Hint:  He bought it used).

All day at work, he is distracted by thinking about his car, and when he leaves work, he is excited to see HIS shiny new car in the parking lot.  And he enjoys driving it home.

There are a few major flies in the ointment.  The first is insurance.  His agent wrote a "binder" on the car, based on the amount James had paid for the insurance on his older car.  But the Agent calls the next day with bad news - the cost of collision insurance on the car will be very high, thanks to some tickets James got, and in addition, the comprehensive will be higher, as the coupe is classified as a "sporty" model with higher premiums.  The insurance will cost a couple hundred per month for the car - nearly as high as the car payment.

The other problem with the scenario is that James thought that "a few hundred" a month was affordable, but did not "do the math" to figure out where the money would come from.  As it was, he was spending every penny he made every month, on rent, beer, and partying.  He thought that he would "save money" by not having to pay for repairs on his old Honda (which needed new tires, just last month!) and maybe cut back on some other personal expenses.

But that sort of financial acumen is rather faulty - the idea that you can add hundreds of dollars per month to your budget and "somehow" economize to afford it.  Needless to say, James was very quickly running out of money every month.   The jacked-up insurance rates only added fuel to the fire.  Very quickly, his credit card balance started increasing.  He not only took on a staggering debt load with the new car, but was increasing his debt load with the credit cards.  His net worth, including student loans, was astoundingly negative.

Only 71 months of payments left to go!  James would be nearly 30 before the car was paid off.

What was worse, is that James had no way out of this situation, other than to work for six years and pay off the debt - and hope in vain that his salary increases over time would make things easier.  Yes, he was upside-down on the car, and would remain so, for the life of the loan.  He would not be able to sell the car for what he owed on the loan, for many years, as the onerous terms of financing meant that the car was depreciating faster than the loan balance was decreasing.

Right off the bat, the car was worth 10-20% less than he paid for it, the moment he drove it off the lot.  Within 3-5 years, it was worth 50% less than its purchase price.  From a depreciation standpoint, a new car is a horrible financial transaction.  But James never looked at the deal in terms of overall price, overall cost over time, and overall cost-per-mile, in terms of transportation.  He just looked at that inviting low monthly payment.

"The Road to Middle-Class Poverty is Paved with New Car Payments" - as one famous author (me) once said.  And many a young person has been snookered into buying a brand-new car, and then can't understand why they are not saving money or can't balance their budget every month.  It can't be the car, right?  Not the car!  Everyone has new cars, right?  RIGHT?

Wrong.  And often the "monthly payment" mentality fails to address the overall cost.  So James is broke now, and living "paycheck to paycheck" and the cause of his financial difficulty is parked out front.

A decision he made one night, under pressure from a salesman, when he was 23 years old, will affect him for an entire decade.  Five years into this deal, he has a used economy car that is out of date, out of style, and starting to show signs of wear - and incurring repair costs.  The fun part of driving a new car with temp tags lasted a week.   The financial effects lasted a decade or more.

More - because at age 30, he wants to settle down and get married, but he has nothing to show for the last decade of his existence on planet earth, other than a clapped-out economy car, and some electronic gadgets - and  few grand in credit card debt.  Getting a mortgage to buy a home will be hard.  He can only hope that his future spouse was smarter about money that he was - or comes from a wealthy family.

The new car showroom is a trap for young people - a trap that can suck the money out of your wallet for years and years.  Your 20's should be a time for fun, frolic, dating, and experiencing all the joy of life as an adult for the first time.   But that excitement alone is fun - you don't need to enhance it buy owning shiny new crap.  Trust me that it is far more fun to drive Mom's clapped-out Honda and have $20 in your pocket, than to have a new econo-box and be broke all the time.

And it is even more fun to be putting money in your 401(k) in your 20's, so that age 30, you have a down payment for a home, should you decide to buy one.  Financial security is not sexy or flashy, but it is really calming and reassuring, in the long run.

So what could James have done differently?  Well, he could have kept driving the Honda for a few more years, enduring the ribbing of his pals (who ironically, all want to ride in it, when they go somewhere as a group, as their economy coupes do not comfortably seat more than two).  He could have put the hundreds of dollars a month of savings into a savings account, and when the Honda finally blows a head gasket at 250,000 miles, he could have afforded to buy a secondhand GT coupe, from the original owner, five years old, for CASH - and saved a ton of dough in both interest, insurance, and depreciation.

And moreover, he would not have been broke all the time, or felt the pressure and strain of "having to make money" in order to pay bills - bills of his own creation.

* * * 

The story of James is not made-up.  I know a lot of James' out there - and am one myself.  I bought a new car, at age 23, when I had a perfectly good used car that would have given me five more years of service - easily - with proper care.  With the cost of insurance and car payments, the price of ownership was astounding - hundreds of dollars a month, in an era where mortgage payments or rent was not much more.

By my late 20's, even though I had been working for a decade, contributing to a 401(k) plan at two companies, making a fairly decent salary, and even buying and selling a home and pocketing several thousand dollars in cash, I was in fact, flat broke.  And what did I do at that point?  You guessed it - I went out and bought another new car.

The only smart thing I did do, was to get an eduction, which in turn qualified me for a better job with more pay.  But like most young people - or people in general - I merely made things worse by going out and increasing my debt load and monthly bills to the point where I was treading water - running hard to stay in one place.  Rather than capitalize on my gains, I was just staying in place, if not in fact falling behind.

It was not until I first sat down and calculated my net worth that I realized that a decade of hard work had come to naught.  I had not been able to save up even a few hundred dollars over that entire time period!

And, at that point in my life, I decided I needed to change things.  And to be sure, it took decades more to figure things out - there would be more cars, more onerous deals, more debt, and more stupidity before I realized that such a lifestyle was not sustainable in the long run.  Eventually, we all have to retire and live off our savings - so learning to accumulate wealth and live on less is not really an option, but a dire necessity.

And living in debt all the time wears on your soul and even your body.   The stress of debt leads to physical ailments and to drinking, drug use, and escapism.  Many people today are very unhappy and take anti-depressants, and wonder why, while living in the richest country in the world, they are so miserable.

And often the reason why is parked in their driveway.  They have lots of nice stuff, but also lots of debt.  So they feel powerless and weak, instead of empowered and wealthy.

It is hard to break free of this cycle of debt-and-owning-things.  And it cannot be changed overnight, particularly when you have signed up for years of onerous debt.  It takes only the stroke of a pen - mere seconds, to bind you for decades.  But you can turn things around, over time.  And it is worthwhile to do so.

And yet, many people, not seeing results right away, say, "screw this, I'm buying a new Camaro!"

And the cycles continues...