Saturday, December 29, 2012

Hidden Costs of Car Buying

There are a lot of hidden costs in buying a car - costs you might not think about while looking at a shiny new car under the bright lights of the dealer showroom.  The dealer says you are approved for the loan, but think about other costs before you sign on the dotted line.

I was having the front-end aligned on the X5 the other day.  I had replaced the struts, control arms, ball joints, tie rod ends, axle half-shafts, wheel bearings, and a number of other parts, which requires that the front-end be re-aligned (actually all four wheels aligned on this car).  While I was waiting, I went though our service records and noticed that there were a lot of costs in owning a car that I had not thought about.  (I keep all the records for the car in a big binder with page protectors.  It is interesting to see how much you can spend on a car, over time!).

When we bought this car, secondhand, in Florida, we paid $25,900 for it.  It had a little under 50,000 miles, and was four years old, and the price paid was a little more than half the retail price when new (again, most cars depreciate about 50% every five years).

We've put 100,000 miles on it, over the last six years, and it is showing signs of age.  The end game might not be here yet, but I can see it on the horizon, and I am starting to think about what to replace the vehicle with.   As its resale value drops to below $10,000, and as small things start to break and become annoying, it is only a matter of time before we have to buy something else.

But what?  And when?   Does it make sense to jump ship now, or hang on until the bitter end?   The more I started investigating the matter, the more it dawned upon me that there are a lot of "hidden" costs in buying a new or newer car - costs that we don't think about when looking at the shiny dealer brochures.

1. Taxes

In going through my records, what staggered me was the sales tax we had to pay to Florida - a whopping 5% or more, totaling over $1500 just in taxes alone!  And yes, $1500 is a lot of money.  I have bought cars for less than this.

And that is the irony right there.  A lot of people will "dump" a used car because it needs $1000 in repairs, and then go out and buy a new (or newer) car and pay $1500 in sales taxes right off the bat.

And the tax man doesn't end his bite there.  In many jurisdictions, an annual property tax or ad valorum tax is added to your registration fee, or collected separately.  Until recently, in Georgia, we paid this tax - about 1.2% every year, or about $250 on a $20,000 car.   In Alexandria, Virginia, we paid "personal property taxes" as high as 4.5% on our cars - which could be well over $1000 a year on even a modest mid-sized sedan.

And you wonder why this "tax revolt" thing has taken hold in the South.....

Your used car, parked in the driveway, requires no sales tax payments.  And moreover, since it has a very low "book value" your ad valorum or property tax every year, will be low - and get lower over time.

Here in Georgia, they recently abolished the ad valorum tax and claimed to abolish the "sales tax" on cars.  But of course, they just replaced these both with a one-time title tax of a whopping 7%.   So on a $20,000 car, you will have to cough up $1400 just in "title tax" before you can drive it home.  And yes, $1400 is a lot of money.

(UPDATE:  In Georgia, the "sales tax" was only applicable to sales from Car Dealers (you would think this would have boosted private party sales tremendously, but most folks don't think that carefully - and that is why these are "hidden" costs).   Effective March 1, 2013, the "Title Tax" will be applied to all car sales, dealer or private, and the Ad Valorum tax will go away for cars titled after March 1, 2013 (according to the radio).  However, the Ad Valorum tax will still be applied to cars you own before then.  This amounts to about $50 a car for me.  However, you may opt to pay the Title tax between now and then, and avoid the Ad Valroum tax perpetually.  It appears that an interesting "loophole" exists between now and March 15.  If you buy a car from a private seller between now and then, you can pay the 6.6% sales tax but you won't have to pay Ad Valorum tax.   Or, if the car is of lesser value, you may opt to pay the Ad Valorum tax, particularly if you are buying from a private seller and don't plan on keeping the car very long.  An interesting calculation would have to be made.)

But most people don't think about taxes - or if they do, they think about their Federal Income Taxes, which of all the taxes they pay (if indeed, they pay any) are likely the smallest of any single tax.   There are people in the middle class or lower middle class who likely would pay more in sales taxes in any given year than they do in Federal Income tax.  But they are all teabaggers and convinced that Obama has "raised my taxes!".  Go Figure.

But to people with poor money skills (which was me, until a few years ago) sales tax is sort of a "whatever" kind of thing - the cost of doing business and a trivial few percentage points.   And when the tax is 4% or less, I guess we can think that.  But in places like Georgia and New York, where the tax is 7% or more, it becomes a big deal - even for small purchases.

Of course, one way to cheat the tax man is to consume less.   A $10,000 car has half the tax bill of a $20,000 car, and so on.   And this applies to all parts of your life.  If you spend a dollar less, the tax man is cheated out of seven more cents.   The more you consume, the more taxes you end up paying.

The best used car value is often parked in your driveway - as I like to note, time and again.  If you decide to "swap" cars on a regular basis, you end up paying a lot in transaction costs alone, including this sales tax or title tax, or whatever - plus other tag and title fees.

Of course, eventually, all cars wear out, and you have to get something newer to drive.  Death and Taxes - they are unavoidable.   But the longer you can cost-effectively keep your car, the less you pay in taxes, overall, in your life.

If you have a car that is getting old - but is still serviceable - think about whether you are buying new or newer because you need a new car, or merely because you want one.

2.  Insurance

I have very cheap insurance through GEICO.  I pay about $16 a month in liability coverage, and if I want it, Collision and Comprehensive is another $17 a month.  That's about $420 a year, which is pretty cheap insurance coverage.  Most people pay far more than this for car insurance.

GEICO rocks, and their website is very well done.  By going online and logging in, I can get a quote on the cost of deleting one car and replacing with another.  If I delete the X5 and replace it with a $22,000 Nissan Pickup truck, my insurance will go up by $295.20 a year.

Again, this might not seem like a lot of money to most folks, but it does add up, over time.  If you add this to the sales taxes and the ad valorum taxes (if applicable in your jurisdiction), you may be looking at close to $2,000 just in added expenses during the first year - above and beyond the car payments you make.

And this is assuming insurance rates remain constant.  The big trap - as I have noted before - for younger people, is to buy a new car, get some speeding tickets or get in an accident (or a DUI), and then see insurance rates spike to $3000 a year or more - sometimes far more.   At age 25, you can buy a new car, get a few tickets, and literally go bankrupt.

And those car payments aren't cheap, either.  Even at low, low financing rates, you are looking at $400 a month or more for payments on even a modest car.   Paying cash may save you a little in interest charges, but it still takes a huge dent out of your net worth.

Again, overall costs trump monthly expenses but most folks only think in terms of the latter.

UPDATE: We finally sold the X5 at 160,000+ miles.  The new Nissan pickup, which cost about the same as the X5 used (actually, less) costs about $35 a month, including collision and comp ($1000 deductible) versus about $29.81 for the X5.   Of course, we are older, don't commute, live on an island, and have a clean driving record.   For younger people who commute and have traffic tickets or an accident or two, insurance costs could be 10 times this amount, and often exceed the monthly car payment. 

It pays, if you are younger, to buy a secondhand car that does not require collision.  For the price you pay to buy a brand new car and pay for the insurance, you could buy four used cars.   But most young folks don't look at it that way.

3. Loan Costs:   If you finance a car purchase (new or used) they often tack on "loan document fees" or some other such crap, if you finance through the dealer.   Some dealers have the chutzpah to tack on as much as $500 in "document fees" or some such nonsense - if you are dumb enough to pay it.

And of course, you pay interest, although today this is far less than the 10% we used to pay.  Even if you can get one of these 2.9% financing deals (which are usually a gag - they tell you that you can't qualify and offer you a higher interest rate) then you end up paying $1509.40 in interest, over five years.

There are other costs, of course.  Many dealers charge you a nominal amount for temp tags and licensing the car.  They collect a whole bunch of registrations together and then once a week (or month) send a low-paid flunky down to DMV to stand in line for all of them.  This saves you time, of course, but you do pay for it.  And as likely they will get you new tags, you will pay a new tag and registration fee as well.   This can end up costing $100 to $250 depending on the dealer.  If you buy a car from an individual or do the tagwork yourself, you may be able to transfer tags and save some money here.  But few people do it.  Why?  Because they are spending $20,000 or more and think that "$100 isn't a lot of money!"

Note that I didn't raise opportunity cost arguments here.  A dealer salesman will say stupid things like, "If you pay cash for the car, you are losing the opportunity cost of investing that money!" - particularly when they are trying to lease you a car.   The argument makes little sense and can be cut both ways.   Buy purchasing the car, period, you are forgoing the opportunity cost of putting $22,000 into your IRA or 401(k), at the rate of $500 a month.   Borrowing money to save money is an argument that makes no sense at all.

4. Overall Cost to Your Net Worth.

The main thing people miss, in buying and selling cars, is the overall cost of the transaction, or the dent it puts in your net worth.  Let's take a look at the overall transaction costs of keeping the X5 for another five years versus buying the small pickup truck.

If we assume that a vehicle depreciates about 50% in value every five years (which is a rational assumption, as most vehicles fall roughly within this range), the X5 will depreciate about $4500 in five years.   The new or newer Nissan pickup will depreciate $11,000 in the same five years.

The sales tax will be 7% or about $1540.  Since we don't have ad valorum taxes anymore, we can skip that.  But the insurance (at $292.20 per year) will be an additional $1462.50 overall, for five years.

The gas mileage and general maintenance (oil changes, etc.) will be about the same, although some dealers are offering "free oil changes for life" as an incentive to come back to the dealership often, to sell warranty service or to try to entice an owner into a new car.  Oil changes are so infrequent these days, and so inexpensive (if you do them at home) that this is not a major expense.   But let's throw in $100 a year for oil changes.

Repairs are where things get hard to calculate.  It is not possible to precisely predict repairs on an older car.  And whether a car will last another X miles is difficult to predict.  Usually, what kills off a car is an accident or repair that exceeds resale value.   So even a minor collision or an engine or transmission overhaul is enough to send most 10-20 year old cars to the wreckers, in short order.   At 140,000 miles, I think we can safely assume that the major components of the X5 will last until 200,000 miles or so, although the engine will likely be using more oil by then.

But the car will likely need a new set of tires ($600 to $1200) before then, and perhaps a new clutch ($1200) as well as other miscellaneous repairs and overhauls (although I have replaced so many parts on the car already, that perhaps the latter is not that great).  But let's assume $1000 a year for repairs - which is generous - which would amount to $5000 over five years.

So, which is the better deal over five years?

New (or Newer) $22,000 Pickup truck:
1.  Depreciation:  $11,000
2.  Sales Tax:    $1,540
3.  Insurance (increase):  $1,462.50
4.  Repairs:  $0

Total:  $14,002.50
Interesting to note that on a $22,000 truck, the actual costs, over five years, are nearly 3/4 of the sales price.  So how does this compare to keeping the older car for five years?
1.  Depreciation:  $4500
2.  Sales Tax:  $0
3.  Insurance (increase):  $0
4.  Repairs: $5000

Total:  $9500

Savings: $4502.50

So there is considerable savings in keeping the older car - about $1000 a year.    Add in loan interest (if applicable) and you've got another $1500 in the mix.  And this calculation was made by generously assuming that repair costs would be $1000 per year.   But as a consumer, I have some control over repair costs, as I do a lot of work myself (the front end work cost $700 in parts, whereas a mechanic would have charged over $3000 for such a repair, and the dealer, over $5000)  and also I can control repairs to some extent by how aggressively I drive the vehicle.  So the savings could be even greater.

When you buy a car, you are jumping on a new depreciation curve.   You pay $20,000 for a car, your net worth is decreased by $20,000 and increased by the resale value of the car (usually 10-15% less than the price paid for the car, if bought new).   And over time, you use up that car, and eventually end up poorer as a result.

The longer you can keep a car, the further you come out ahead - until the car reaches its end game.

* * * 

There are a couple of caveats and "But, what about..." kind of things that I am sure that some folks will point out.

1.  You'd have to pay the sales tax eventually:  Yes, it is true that the X5, like most cars, will go to the boneyard eventually.  Even cars that end up as "collectors items" end up going out of service, as they become more talismans of cars than actual cars.  People keep an old muscle car in their garage for 40 years, true - but they don't drive it as general transportation, as a general rule.

So it is true that this car will be junked someday, and I likely will "fish further upstream" for a newer car.  And at that point, I will have to pay that $1540 in sales tax.

But a tax deferred is a tax denied.  If, over your lifetime, you buy 10 cars for $22,000 each, you will pay $15,400 in sales taxes on those cars (at the 7% rate, anyway).  On the other hand, if you can buy 9 cars, or eight cars, you will save $1540 for each car you don't end up adding to your collection.

Life is finite, and the number of cars you own is finite.  So there is a real savings on deferring a tax, if you can possibly do it.   And there is an additional savings in that the money not paid in taxes is money that stays in your 401(k) or could be invested - yielding income over time.  And yes, this is an "opportunity cost" argument - but one that makes sense, when you are saving money (car dealers will use "opportunity cost" arguments to convince you to buy, but such arguments are specious at best.)

Similarly, while all cars depreciate at about the same rate (about 50% every five years) the cash amount is less as the car gets older.   In your lifetime, if you buy 10 cars for $22,000 each and keep each car for five years, you will spend about  $110,000 in depreciation.  On the other hand, if you buy 5 cars for $22,000 each, and keep each one for 10 years, you will spend about $82,500 on depreciation - a savings of $27,500 over your lifetime (which is more than most people have in their 401(k)).

2.  Reliability:   A lot of people say, "Well, I need a car that is reliable as I have to get to work!"  And this is true.  But reliability and age of a vehicle, while related, do not necessarily go hand in hand.

As I wrote before, the Weibull curve does kick in, over time, and eventually it makes no sense to keep a car forever.  Cars wear out and it is time to junk them - eventually.   But the reliability thing is, to some extent, a function of how you care for a car and what kind of car it is.

A clunker near the end of its design life, that is treated indifferently, will tend to leave you by the side of the road, on occasion, and this can be inconvenient.  But, if you have AAA towing, it need not be expensive.  And if you don't panic and throw money at a car, it need not be costly.

During my last trip North, the X5 coolant expansion tank (which is pressurized) started to crack.  I noticed the "coolant low" light come on more than once, and after refilling the coolant a few times, I noticed that there was a small crack in the bottle.  A quick drive to the dealer and $180 later I had a new coolant bottle, which took an hour to replace (it snaps in).

Even if I had to go to a mechanic, this would have delayed my trip by no more than a day, and cost maybe $300 to replace - well within my $1000 annual budget above.

But of course, many others are not so handy - and many people are afraid of breakdowns "on the road somewhere".   Fear is a good selling tool, and not surprisingly, dealers use it to sell cars.

In my experience, however, the "reliability" argument is used by people who want a new car but don't necessarily need one.  They get Grandma to co-sign a loan saying "Grandma, I need a new car to get to work!  I don't want to break down on the road somewhere and get raped!"  And Grandma, finally glad that their granddaughter is "off crack" and "has a job" will fall for this argument, oblivious to the fact that while her 20-something granddaughter is tooling around in a brand-new car, Grandma is driving a 10-year-old Buick.

So no, other than end of design life issues, the "reliability" issue makes no sense.  Most modern cars can be run reliably for 10-15 years before they reach the end of the Weibull curve.   Selling a car at the five-year mark is just vanity.  Leasing every three years, even more so.

If my car breaks down, I'd just go and rent one for a while.

* * *

The point is not that you should keep your car forever.   That is not practical, affordable, or physically possible, in most cases.   The point is that the longer you can keep your existing car, the cheaper it is to drive.   Constantly trading in cars every 3-5 years results in a lot of excessive costs, both in terms of sales taxes, as well as depreciation and insurance costs.

When repair costs exceed the value of the vehicle, then junk it and buy something newer.  But buying new cars, serially, is one sure way to squander a lot of cash.

But until then, the best used-car value is likely parked in your driveway.  The more crap you buy, the poorer you will be, over time, not richer.   

UPDATE:  We managed to get another year of use out of the X5.  Sadly, it had depreciated to about $5800 in value, and with 160,000 miles on the clock, wasn't worth much.   While once a common sight on the roads, the E53 chassis is not very much seen today, a function of the high cost of repairs versus the small resale value (most were automatics, and the cost of replacing or repairing that transmission exceeded the resale value of the car, even if they "looked good" after 15 years or so).   We hope to keep the next car for about 10 years or 150,000 miles as well.

The point of the article isn't to keep your car for 20 or 30 years, but not to trade every 3 or 4 - which many Americans do, and think is "normal".   When you churn your personal auto inventory, the transaction costs, particularly the sales taxes, can add a lot to your bottom line.

NOTEIn most States, you do get a sales tax credit if you trade-in your car.   While this may make trading in seem more appealing (and I am surprised more salesmen don't use this argument!) the overall transaction costs of doing business at a car dealer often wipe out these savings.
"The state of Oregon has no sales tax, so if you live in that state and buy a car, the tax calculation is easy -- zero. In seven other states, there is no credit or sales tax reduction when you trade in a car. Those states are California, Hawaii, Kentucky, Maryland, Michigan, Montana and Virginia. If you live in one of these states you calculate sales tax by multiplying the full new car purchase price times the local sales tax rate."
But hey, all you car salesmen out there, feel free to use the argument, along with "opportunity cost" as well.   Not that I'll believe it!   But it will help customers sell themselves on the idea....