Can You Afford Your Car?

Seems like a strange question, right? Owning a car is a basic need for most people. A car’s primary function is to get us from A to B safely. They are also a depreciating asset. A car depreciates because its mechanical components deteriorate with use over time. Old, high end, rare collectible cars can appreciate if well maintained. The car market is full of different makes, models and prices. This is because each of us have different needs, wants and tastes.

 

Buying A Car

Buying a car is a major purchase. Needing a new car and wanting a new car are two different things. We need a new car when the repairs cost more than the value of the car, if the car constantly breaks down, if the car is unsafe, when we have children or our lifestyle changes.

 

Needing a new car can quickly develop into wanting a new car based on personal taste and social status. Cars like all other material goods can be an extension of our own personalities and brand. It’s nice to have nice things. Whether it’s a need or a want, new or used, owned for four years or fifteen years, what matters most is affordability. Affordability when buying and running our car relative to our own specific circumstances.

 

I have observed a variety of different strategies around car ownership. Some buy new and keep for fifteen to twenty years. They look after the car well and it looks after them. There is little residual value left at the end of the fifteen to twenty years. Some buy a five-year-old car and keep it for ten years. They avoid the initial hit of depreciation on a new car and can often buy a more premium car given the reduction in the original purchase price after five years. There is some residual value left in the car at the end of fifteen years. Some buy new and every three or four years buy new again. Depreciation is high but so is the residual value of the car. Which one is best financially? It’s well documented that new cars depreciate at a higher rate than usual over the first couple of years. Therefore, we typically get more bang for our buck buying a car that's a few years old.

 

Affordability and Depreciation

How do we determine if we can afford to buy a certain car? The short answer is depreciation. The Volkswagen Golf has consistently topped or been in the top five cars sold in Ireland over the last five years. A new VW Golf is safe, reliable, economical, has a strong secondhand market and is at the lower to middle end of the car market based on price. A new Land Rover Range Rover has consistently ranked at the bottom of car sales in Ireland in the last five years. The Range Rover is safe, uneconomical, has a reasonable secondhand market, and is at the high end of the car market based on price. I will use these car makes and models as examples in my analysis.

 

The below table represents the year, price, and depreciation percentage over fifteen years of one of the best selling cars in Ireland, the Volkswagen Golf and one of the worst selling cars in Ireland, the Land Rover Range Rover. The major difference between the two being price:

Car Year

VW Golf Price

Range Rover Price

VW Depreciation %

RR Depreciation %

2021

€32,000

€130,000

0%

0%

2016

€16,500

€60,000

48%

54%

2011

€8,000

€24,000

52%

60%

2006

€2,000

€6,000

75%

75%

Saving for A Car

A new VW Golf costs €32,000 and a new LR Range Rover costs €130,000 or over four times the VW Golf. They both lose half their value through depreciation every five years or so. Say we bought a five-year-old VW Golf which costs us €16,500 & a five year old Range Rover which costs us €60,000. We will upgrade the cars in ten years time. In ten years’ time we will receive €2,000 for the VW Golf and €6,000 for the Range Rover. When we subtract these residual values from the purchase price of our future five year old car, we are left with €14,500 and €54,000 respectively. In order to be able to fund our future car we need to have been saving €121 per month for the VW Golf or €450 per month for the Range Rover for ten years. 

 

If we are able to save the necessary amount per month from our income, we are able to afford the car. Car price, depreciation and ownership term will determine affordability. The first two can be estimated by researching www.carzone.ie and the third is personal preference. It’s important to remember the cost of car depreciation throughout our life, the time required to earn that money and the opportunity cost of spending more than is necessary on cars relative to our other financial goals. Good and bad money decisions compound. 

 

Borrowing for A Car

A car is a perfect example of an irregular cost that many people fail to save for adequately ahead of time. It is often the irregular future expenses that catch us out. We are then unprepared for when a new car is needed. As a result, many new cars today come with a new car loan too. The path of least resistance and instant gratification is debt. Our emotions take over and our financial wellbeing takes a back seat. Personal contract plan, car loan, leasing and hire purchase are some of the debt options available. Choosing debt might mean we were unable to afford the car in the first place. This makes it twice as difficult to get out of debt and afford our next car without dipping into debt again. We are paying more for a car that is halving in value every five years. Even if there is a zero percent interest rate we can bet much of the interest we would have paid is baked into the sale price. Often our emotions can get the better of us to the detriment of our financial wellbeing. What we need, can afford and what we want can begin to diverge.

 

Let’s take a Personal Contract Plan as an example given their popularity. A VW Golf costs €32,000 and we put down a 10% deposit of €3,200. This leaves us with a balance of €28,800 to finance. With an Annual Percentage Rate (Interest rate) of 5.9% and repayments spread across five years the monthly repayments will be €372. The total interest paid will be €6,174 over the five years. At the end of the five years, we have three options:

 

Option 1: Hand back the keys and walk away without a car.

Option 2: Pay the optional guaranteed minimum future value payment of €13,000 and own the car.

Option 3: Sign up for another five years PCP on a new car.

 

Option 1: Unless you have been saving for a car or have a second car, option 1 isn’t really a runner for most people. Between the 10% deposit and 60 monthly repayments of €372 we will have spent a total of €25,536 over five years and be left without a car. It will be hard to walk away from that sunk cost. The current value of the car after five years is €16,500.

 

Option 2: Pay €13,000 and keep the car. If you have saved an additional €217 per month on top of the €372 monthly repayment you can buy the car outright. The real cost of the car including the guaranteed minimum future value is €589 per month if we plan on buying the car at the end of five years. This is a lot more than the headline figure of €372 per month advertised at the beginning. Between the 10% deposit, 60 monthly repayments of €372 and guaranteed minimum future value payment of €13,000 we will have spent a total of €38,536 over five years. The current value of the car after five years is €16,500.

 

Option 3: Rinse and repeat the original PCP process.


Car financing is designed to sell more new cars. It is a self-serving and lucrative business. Most folks couldn’t ordinarily afford a new car by saving up for it. Car financing is structured in a way that helps car manufacturers and dealerships provide the public with a more “manageable” option to new cars. More manageable does not necessarily mean affordable. Car financing is debt and debt on a depreciating asset is bad debt. It is not good for your financial health.

 

Besides the potential unaffordability, car financing can impact our lives in other ways. What happens if you get seriously sick, lose your job, are saving for a wedding, saving for a deposit on a home, applying for a mortgage, are planning on having a family, want to renovate/extend or upsize the home, saving for financial independence and saving for a rental investment property. These are all costly expenses and having bad debt will impede our ability to save and borrow in the future. Monthly debt repayments increase financial risk in our lives and reduce our ability to save and build wealth. Debt costs us more and we will have less income to save or spend on other things.

 

Running A Car

Car running costs will fluctuate depending on make, model and mileage. The main costs to consider are fuel, depreciation, insurance, tax, NCT, service, maintenance, tolls, parking, repairs and driving license. This excludes car financing repayments, if applicable. The average cost of running a family car in Ireland in 2019 was €10,691. The average wage in Ireland is €49,000. After tax we are left with roughly €39,000. The car costs us over 25% of our take home pay per year. In this scenario we are at work 25% of our time to pay for our car.

 

Here are a few questions we might ask ourselves when making a decision on car ownership:

 

Do we need a car?

Do we need two cars?

What are the alternatives? 

Can we work from home, use public transport, cycle, walk, run, use car sharing or be more organized?

How much time do we spend at work to buy our car?

How much time do we spend at work to pay for running our car each year?

 

I like many others have been working from home for the past year. I typically use the car three times a week for journeys of no more than 10 kilometers. When I was working, I used the car four or five times a week. I cycled to work Monday through Thursday all year round, only driving to work on Friday’s. I found cycling great exercise, cheaper and often quicker door to door than driving. The number of trips in the car reflected the distance between where I lived, worked, and socialized with family and friends. What I thought was a necessity wasn’t actually the case. A perceived need was actually a want. We all have different lifestyles and circumstances but for me car ownership is a luxury expense based on my current circumstances.

 

Then I started to ask myself how much the car was costing me per trip. Three trips a week for fifty-two weeks a year is one hundred and fifty-six trips. If I use the average cost of running a car of €10,691 per year, each trip costs me €69. If we divide our per hour after tax income into the cost of each trip we will know how much time we work to pay for each trip.


Summary

Work out what our current car(s) cost us to buy and run based on how often we upgrade. Then begin to save for the car by incorporating it's future purchase and running costs as a portion of our recurring income. Forcing ourselves to save for our car rather than choosing debt will quickly lead to a realization of how much our car actually costs us.


Link to Spotify podcast episode: https://open.spotify.com/episode/3KC4zCD4trP1hfuqvpSzGY?si=3b7524833ad74977

Link to Apple podcast episode: https://podcasts.apple.com/ie/podcast/s2-e4-can-you-afford-your-car/id1539630506?i=1000538514311

For personal financial planning advice email team@vantagefp.ie or call (01) 539 2670.