Should you buy a new or used car?

Should you buy a new or used car?

Conventional wisdom might say there is more value to be had in a used car, after all, the worst depreciation happens in the first few years after purchase and then levels off in later years. While this is true in theory, in the long term there are some other significant factors that can change the equation.

 Before we begin, if you are not in a solid financial position then do not buy new. Buying used is a safer approach than new which should only be reserve for certain situations and for people who are in great financial condition. The following are prerequisites that must be in place for it to make sense to buy new:

  • You have excellent credit
  • You bring in at least 5 times the car’s price in annual income AND have a savings rate of above 10% outside of retirement savings. Said another way, you could save up the amount to pay in cash in two years or less.  You may not want to pay in cash – more on that later – but you could if you wanted to
  • You will be happy with the car for a long time, and won’t be tempted to trade it in too soon
  • You maintain your cars properly
  • You are planning to buy a standard car from a reliable brand (read: Honda or Toyota); not a luxury car brand

If you meet the above criteria, it may be a better bet to buy new in terms of value and here is why:

1)     Transaction costs. There are costs incurred with each transaction of buying or selling a car, and when you buy used, you will need to buy more often. Used cars will naturally last for fewer years than a new car since they are further along their useful life when purchased. For example, during a 10-year period you may buy (and sell/trade-in) two used cars while had you bought new, only needed to buy/sell one new car. When you buy a car, you incur a dealer’s markup and then when you sell trade in your old car, again you are dealing with a lower offer from the dealership. Going through this buying/selling process fewer times will be much more cost effective. There are other costs associated with each transaction such as sales tax and registration fees when you purchase a car. 

You might be able to mitigate some of these transaction costs by transacting with private parties as opposed to dealerships, but this is a lot more work as well as risk as there won’t be a warranty program that a private party can offer. Speaking of risk….

2)     Higher risk. When you buy a used car, you are inherently taking on more risk that the car was not well maintained or was involved in some accident/sustained damage that was not reported. Used cars may not last quite as long as cars you owned since they were new (assuming you properly maintain your cars).

 3)     Opportunity costs. If you have excellent credit, new cars can often be bought with manufacturer financing at below market interest rates (as low as 0% to 1.9%). This is essentially a loan for less than the long-term average rate of inflation. With used cars, interest rates are much higher. NWW does not endorse taking a car loan out unless it is at an extremely low interest rate (i.e., below inflation rate). You can then use the upfront savings to invest in assets such as stocks. This assumes you are very disciplined at saving and investing, and will not blow the money that you saved upfront on unnecessary expenses.

 If you have bad credit, a lower income and savings rate or are not quite as disciplined yet with money, then a used car is your certainly your best bet. But if you have excellent credit, high income/savings and are good with money, then in the long term it’s better to buy new, hold for at least 10-12 years and trade-in for a newer model at that point. Just remember to buy reliable cars, maintain those cars properly and don’t buy more car than you need/can afford.