It pays to heed the rules of car buying

By any measure, we are big into machines that guzzle petrol.

There’s a car for every one and a half of us.

That’s perhaps not surprising given our geography, poor public transport systems, and the prevalence of twoworking parent households.

Four-wheeled personal mobility machines are so ubiquitous, it is hard for most adults to imagine life without one for their exclusive use.

But cars are expensive to buy and run, and spending too much on motoring can seriously retard wealth accumulation.

Collectively, Statistics New Zealand data shows, households were spending 14.1 per cent of their incomes on transport in 2013, much on cars.

Given its importance in household finances, it’s fair to ask the question: How much is too much to spend on motoring?

It is human nature to love rules, and plenty have been offered on the subject.

The 10 per cent rule

This says spend no more than 10 per cent of your annual income when you buy a car.

According to this rule, if you earn $60,000, you should be driving a car you bought for $6000. A household earning $120,000 could have two such vehicles, or one nicer one.

Depending on mileage and car size, a $6000 motor is likely to be between 10 and 15 years’ old, and at that age you enter a mechanical failure lottery.

The AA creates reports each year on the estimated costs (including depreciation, which most people ignore) of motoring for different kinds of cars.

But its consumer affairs expert Andrew Bayliss says for older cars it is simply impossible to estimate repair bills. If the transmission of an older car fails, it could cost $4000 to replace.

‘‘But if something in the car does not fail, it is going to cost next to nothing to run,’’ Bayliss says.

Ten per cent is a nice round figure, but its arbitrariness invites challenges. What if my car is my only hobby? Ten per cent isn’t as much for someone who owns their house mortgage-free. It’s a fortune for someone saving for a first home.

The 20 per cent rule

This says spend no more than $20 in every $100 you earn on motoring, including petrol, registration, repairs, insurance and the car itself. That seems awfully high.

That $60,000 earner on this measure could spend $12,000 a year on motoring, which is going to cramp their ability to save.

Statistics NZ shows that on average households spend $46.30 a week buying cars, and $49 a week on petrol, though

averages include non car owners, devotees of public transport, and people whose commute is a short walk.

Focusing on the proportion of your income going on motoring provides a useful benchmark and if you are so minded, to aim to take action to spend less.

The 20/4/10 rule:

As rules go, this one is complex, but then so is life.

The 20 per cent is the minimum amount to put down on a deposit, the finance is for no more than four years, and the total monthly running costs (repayments, insurance and registration) is 10 per cent or less of salary. Turners Auctions says about a third of cars bought in second-hand car yards involve finance arranged at the yard, though some others will be people who are sticking the car on the mortgage to get a lower rate (and are hopefully paying it off double quick time).

Thinking about what is an acceptable deposit is sensible, as is limiting the repayment term. Four years is a long time to be in debt for a depreciating asset, though lenders like GE will go up to seven years.

A $15,000 loan at 15.95 per cent repaid over four years costs $5400 in interest. Over seven years the interest bill is over $10,000.

The $60,000 earner, also observing the 10 per cent rule, could buy a $6000 car with a $1200 deposit, repaying over four years. That would cost them about $1600 a year for four years, leaving $4200 to fund petrol, repairs, insurance and the rest.

‘Total cost of ownership’ rule

Instead of trying to buy using a somewhat arbitrary rule of thumb, some seek to bring science to their car-buying. Trying to focus on the total cost of ownership (TCO) can change your buying behaviour, but it does require some assumptions.

Take car A costing $15,000, and assuming repairs and servicing cost $5000 in the five years you plan to own it, leaving a car worth $5000 at the end. This would have a TCO (excluding insurance and petrol) of $15,000.

By contrast, car B might cost $25,000, cost just $3000 to service and repair over five years, and be worth $13,000 at the end. TCO is the same, so why not own the more expensive car, and enjoy it more?

Financing and the cost of insurance can change this picture, as can mechanical failure.

Aiming for the lowest TCO over the lifetime of a car is something personal finance gurus the world over advocate, but some buyers are clearly willing to pay a premium for comfort and fewer trips to the mechanic.

The pay for luxury out of savings rule

Our roads are clogged with high-spec cars.

They can go off-roads and ford deep rivers, but all they are used for is dropping the kids off at school, and going shopping in.

Financial wisdom states that owning luxuries is fine, but it is madness to buy luxuries on credit.

Switch to cash buying, but save as though you are repaying car debt

This is the nirvana of car purchasing. Unless there are pressing reasons to do otherwise (contractors with a car allowance, for example), save to spend.

A six-year cycle of car replacement on cars costing $15,000 when new, will, over 18 years, cost just around $56,900 assuming a loan rate of 15.95 per cent, and that each loan was paid back over three years. That’s $12,000 or so in interest.

Instead, scrimp, save and go without to buy that first car in cash, then, for the three years you would have been repaying a car loan, save the repayments you would have made. This is your car fund.

Assume an after-tax, after fees return on a balanced fund of 3 per cent, after three years, you’ll have $18,700. Leave it, without adding a bean, and there will be $19,200 or so three years’ later when it’s time to upgrade. That’s either a better car, or a kickstart on saving for the next.

Scrimp, save and go without to buy that first car in cash.