Dave Ramsey is a financial guru to many people. His advice has helped millions get free from crushing debt. This is a good thing for those folks struggling to get by. Unfortunately, Mr. Ramsey, like many of his financial advisor colleagues, is a little too uptight about letting you buy a new car.
There is an advice column that has been circling the internet for the past week. Now that it has shown up five times in my Google Alerts, and has been posted on multiple sources I feel the need to address it.
A woman writes Ramsey for advice, saying she’s 61 and on disability but debt-free and has “more than $1 million in assets.” She needs a new car and asks Ramsey if she should pay cash, lease or finance.
Ramsey’s not a fan of the last two. Here’s what he said:
There’s no way I’ll ever tell you to lease or finance a car. You have a nice, peaceful financial life, and you don’t want to mess that up.
New car leases are one of the biggest rip-offs on the planet. Consumer Reports, and my calculator, both say leasing is the most expensive way to operate a vehicle. And why would you want the hassle of car payments when you’re in such good shape with your money?
I’m all right with you buying a new car, because for someone like you it’s such a small portion of your overall financial picture. I advise people to always buy good, used cars unless they have a net worth or $1 million or more, and you definitely fall into that category. Still, my advice is to pay cash or don’t do the deal. You’re more than able to do this every few years and not move the needle where your finances are concerned.
Go get that new, better car, Linda. Just don’t go into debt to make it happen!
We’ll start with the “never lease” thing. You either like the concept of leasing or you don’t. I’m not here to convince you one way or the other. I will try to give you the best ways to manage that lease if you choose to do so.
Now that is out of the way, let’s move on...
That’s wonderful, Dave, that you gave this woman permission to treat herself to a new car. It sure is a good thing she had a million dollars worth of assets or that new car purchase would have probably ruined her.
You see Dave thinks that unless you are a millionaire you should “always buy good, used cars.” Notice how he doesn’t say how much these used cars should cost. In fact he never actually puts a specific dollar figure on those used cars, he is just convinced that new cars are always a bad idea.
Unless of course you are Dave Ramsey, in which case you get a brand new C7 Corvette.
That’s a nice ride Dave. I assume you paid cash for it?
So why are new cars a terrible move for everyone else? Depreciation. According to a blog he authored titled “Saying No To New Cars”, new vehicles lose 70 percent of their value in the first four years. You can pick up a lightly used vehicle for almost pennies on the dollar!
Except it doesn’t really work out that way with “good” used cars.
Let’s take a Honda Accord for example. I think Dave would agree that an Accord would fall into the category of a “good” used vehicle. A brand new 2015 Accord EX has an MSRP of $26,650. Dave thinks that purchasing this new Accord would be the same as throwing hundred dollar bills out the window, because of the massive depreciation.
If Dave’s math is correct, a four year old Accord should retail in the used car market for 70 percent less than the new one. Now 70 percent of $26,650 is $18,655, which leaves a remainder of $7,995. I wonder how many 2011 Accord EX models we can find for about eight grand?
According to Autotrader, there are currently about 200 Accord EX models for sale. The lowest priced example is $9,770 and it has over 144,000 miles. The next lowest car is almost $11,000 with about 104,000 miles. Autotrader says the average listing price for a 2011 Accord EX is $15,238 and many of the low mileage examples are in the $16,000-$17,000 range.
So much for getting that 70 percent discount on a four year old car. Of course buying a four year old Accord with a $10,000 savings over a new one is certainly a good move. However, the reality is that buyers in the market that can afford a new Accord aren’t cross-shopping 2011 models.
On the other hand, folks that are buying $16,000 Hondas are usually doing so because they don’t have the budget for anything more.
Dave also suggests that great values can be found on the millions of used cars that come from expired leases. I got news for you, Dave... most of these cars are two or three years old. But even a two year old car has to be cheaper than a new one. After all, most cars suffer their biggest depreciation in the first two years of ownership. Autotrader pings the average price of a 2013 Accord at $20,135 with CPO examples pushing into the $23,00 range.
Wow... those don’t seem so cheap after all.
What Ramsey and others that share is philosophy forget to tell you on their “never buy a new car!” soapbox, is that no one pays sticker price for a new model. Once you factor in the discounts, many of the 2-3 year old used cars lose their value proposition. You don’t even have to be a master negotiator to get almost $5000 off the sticker price of a brand new Accord.
So wait...it’s possible to buy a brand new car for the same price or even less than a pre-owned one? That’s just crazy talk.
This is not to say that used cars on average are not better values than new vehicles. Tavarish has illustrated time and again that if you play the used luxury car market just right, you can pick up some amazing hardware with a a bit of research, a little luck, and a willingness to put some time and money. Though I doubt that Dave Ramsey would recommend his readers buy an E63 AMG for the same price as a Ford Fusion.
Whether you decide to buy a new car or a used one, it’s time we examine this “cash only” business. Ramsey says -
Still, my advice is to pay cash or don’t do the deal.
He even provides a nice example from his old blog post -
Say that you are thinking about financing a new car with payments of $400 a month, just a little below the average car payment. Your current car is worth around $1,500. If you take that $400 and pay yourself, instead of the dealer, you’ll have a $4,000 paid-for-with-cash car in just 10 short months.
This hypothetical car shopper has budgeted $400/mo for a new car and has a trade worth $1,500. If he took out a 60 month loan at 3 percent interest he would have to finance no more than $22,000 to be around $400/mo. Add in that $1500 trade value and he has a total spending limit of $23,500, which is about what you could buy one of those new Accords for.
Ramsey says he should hold on to his $1,500 car and pay himself the $400 for 10 months, so that he can buy a $4,000 car. Woopie! Now he can buy something like this 1999 Accord with 206,000 miles, or maybe a decent Craigslist Miata.
I’m sure this fine specimen of an automobile is so much better than whatever beater he is currently driving. Of course Ramsey doesn’t take into account that the reader’s $1500 car might be in need of some repairs at this point, and it might not be worth dumping money into any more.
But wait, the advice gets better -
Sell your old car and you’ll have $1,500 to bank as you continue saving $400 a month. Ten months later, you have $5,500 for a used car. Repeat this process again, and you’ll have a $10,000 car just 30 months after you started saving.
Sell the car and put the money in the bank, then put $400 in the bank for next 30 months. Hey, Dave... what the hell is this guy supposed to drive for those two and a half years he is saving for this wonderful $10,000 car he is going to buy? If public transit was such a viable option, then he doesn’t even need to buy a car in the first place.
So Ramsey either expects you to be without a car for over two years to save up, or have enough cash in the bank to plunk down and buy something outright. This is not practical advice for the majority of car buyers. Most people don’t have $15,000-$20,000 in cash just lying around to be used on a car purchase. And even if they did, with interest rates so low it would be pretty foolish to part with that much money in one shot when it can be better suited elsewhere. What most shoppers do have is a steady income that they can budget accordingly.
One piece of advice that Ramsey pushes that I also support is the use of an emergency fund. He says that folks should stash away 3-6 months worth of expenses (usually between $10,000-$15,000) in case something drastic happens. Ramsey also makes clear that the use of this fund should only be used for unexpected, urgent expenses. Purchasing a vehicle would not qualify.
Suppose you don’t have the luxury of have both an emergency fund and separate savings to pay cash for a vehicle. Raiding your emergency stash just to avoid interest payments and debt, doesn’t seem like the best course of action.
Or what if you do have money for both? Is taking on a reasonable car payment at a low APR really so bad? I work with a lot of wealthy clients, many of whom have the ability to purchase their cars with cash. They don’t because they know their money can work harder for them through investments or other applications.
Recently, I had a customer who considered buying, with cash, a $48,000 Mercedes SUV. She was ready to write the check and drive home with her new car. Then she saw the money factor (interest rate) on the lease, and it was almost like free money. She also knew that she likes to drive something different every couple of years and decided to keep her money in the bank. And to think this woman who seemingly had very strong control over her finances leased a brand new car! I guess she is in for a rude awakening in a few years.
The key thing is not to purchase too much car. This is where a lot of financially irresponsible people go wrong. If you are making $50,000 a year, you probably shouldn’t be purchasing a $50,000 car. While there are no hard and fast rules when it comes to how much you should spend on your vehicle purchase, the general consensus is that you should use between 8-15 percent of your gross pay. Though I would suggest you lean towards the conservative end of the spectrum. The point is you don’t have to have seven figures to be able to manage a car payment responsibly.
It all comes down to your priorities and current situation. If you are a young person with a solid income, but no major family expenses such as a house or children, maybe you can splurge a little (but don’t go crazy) on your ride. Where Ramsey and I both agree is that you don’t want to do is sacrifice long term financial planning, for short term enjoyment.
If you absolutely hate the idea of car payments, then by all means pay cash and enjoy the fact that the car is yours. If are looking for the best value for your money, pre-owned vehicles are usually the way to go. Just remember these are personal choices, and financing or even leasing a new car doesn’t automatically mean your destined for financial trouble.
If you have a question, a tip, or something you would like to to share about car-buying, drop me a line at AutomatchConsulting@gmail.com and be sure to include your Kinja handle.