Car purchases are the worst kind of debt

One of the things I often recommend my clients work into their financial plan are major purchases. When it comes to my clients, as well as my own finances, the one purchase I hate the most is buying a car.

You would think I would hate credit cards the most. Don’t get me wrong, they are second highest on my list, but at least we are semi-programed to not want to get into credit card debt. Vehicles, well, they hold a much more emotional lure. People see us driving in them everyday. For many of us, we’ve come to think that others will judge our books by their automotive covers. As if the shape, badge, age and make up of the metal you drive is a direct reflection of your success, or character for that matter.

With a car purchase, you are basically trapped with an asset of declining value. In my opinion, the only thing you can do to make that bad situation worse is to roll the debt from one car into another.

On top of that, many vehicle financing agreements offer lump sum life and/or disability coverage tacked on to the total car loan. Not only are these features overpriced, but your client is paying interest on insurance premiums. It’s absolutely painful to see that happen.

The fact is, car payments can pose a serious threat to the balance of the family budget. I have seen many families driving two new vehicles and often their car payments eclipse their mortgage payment—not in downtown Vancouver or Toronto, perhaps, but in Halifax for sure.

In Canada, the average age of a car on the road is 8.5 years. About 4.5 million cars are sold every year; 1.5 million are new and the other three million or so are used. Many families keep new cars an average of six or seven years, but the payments in many cases may last that long too.

Then there are the used cars that are kept a shorter period of time, say four years on average, but many are also financed over longer periods of time.

Of course, with leases, you’ve always got a car payment. If you own a business and can deduct a good portion of the payment, this may make sense, but many of us lease to get a better car for a lower monthly payment—that adds up costing us more in the end.

In my experience, men are more affected by emotions than woman when it comes to their cars. Many of my male clients have shared with me that they can’t drive a lesser car than they have now because others will think they’ve failed.

When a client tells me things like this I try to walk them down the road of a reality check. I ask them questions like, how is making sound financial decisions for your family, such as purchasing a car you can afford to pay off in three years or less, defined as failure?

What makes you think that others will judge you based on the car you drive? Can those who judge you afford their fancy cars? How can you be sure?”

The conclusion the client inevitably comes up with is, “Of course it doesn’t make sense to spend money I can’t afford to spend in order to keep others happy with their image of me.”

I also point out to them that the perceived quality or luxury of another person’s car says nothing about their character or financial status—it simply tells you how much they will spend, whether they have the money or not.

Car buying tips for clients

I recently contacted David MacDonald, group vice-president of financial services with Environics Research Group, to get his point of view on Canadian purchasing habits when it comes to vehicles. David has spent many years in auto research and formerly worked for well known DesRosiers Automotive Consultants. Here are some of the tips David gives when people ask him for car advice.

Don’t buy unless you need to: For young people, put it off as long as you can. Most people in big cities don’t really need a car, they want a car. Or they want two cars.

Own, don’t lease: Unless you qualify for the tax writeoffs, ownership generally beats leasing (i.e. long-term renting). People leasing come back to the market faster than those who own, so you are constantly financing the most expensive period of the vehicle’s depreciation (the first four years).

Used cars offer greater value: At about the four-year mark a car has lost half its value, but still has a lot more than half its life left. When you are buying a brand new car, you are buying a stock of about 300,000 km. A four-year-old car has about 220,000 km left (at 20,000/year). Buying used offers the cheapest price per unused kilometer. A lot of people are afraid of “buying someone else’s problems,” but car quality is so good these days that concerns like that are rarely experienced. Other people worry that the cost of regular maintenance and repairs of a used car will be too high. The cost of maintenance and repairs is much lower than the annual depreciation hit on newer vehicles.

Buy and hold: Keep a car as long as you can. As long as it is running well and paid off, why incur the costs of replacing it?

Buy quality, not warranties: For me, the best “warranty” is a car with a proven quality track record. Honda and Toyota vehicles command the highest purchasing premiums because according to Consumer Reports, they have the fewest problems. Extended warranties, give you a peace of mind when you buy them but are big profit centres for the dealers. I’ve heard horror stories of how dealers and manufacturers wiggle out of what owners thought they would be covered for.

Find the hidden gems: Not all Japanese cars are great, and not all domestic cars are poor quality, but most are saddled with the domestics’ reputation. It pays to find the hidden gems. For example, the Pontiac Vibe is the twin of the Toyota Matrix—extremely high quality cars—but the Pontiac badge trades at a discount, so you can snap them up cheaper on the used market.

Luxury cars are a luxury trap: Yes, they drive nice and have cool features, but after about year five the problems start to rise and the maintenance costs are much higher.

Boring is sometimes better: Less flashy sedans and minivans are cheaper to own, insure and maintain than sporty cars and SUVs.

Fuel economy is a minor cost: It’s false economy to trade in an older car that gets 20mpg for a new one that gets 30mpg. Gas is only a small part of the annual cost of owning a car. Depreciation and insurance are much bigger costs.

So the next time you have a review appointment with a client or are chatting with them on the phone, remember to let them know that far more than investment return will determine their quality of life now or in retirement. Perhaps you should share David’s tips. Making major purchases part of their discussions with you on a regular basis can help them keep more of that hard earned money, so they can do more with their lives.

While you’re at it, you might want to examine your vehicle purchasing habits and how they fit into your written financial plan. Lead by example, my friends!