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Thursday 16 March 2017

Reader Question - Trade In My Car For A Cheaper One?

This may or may not be the car in question.
Someone got in touch with me with a car related dilemma. I was glad he didn't say that his cambelt timing had resulted in increased wear on his cylinder heads (is that even a thing?) - because I am definitely not the right person to ask about that.

His was more a question of whether it made financial sense to trade in his newly purchased car for a cheaper one.

Now that type of question I can give my 2c on...

The person who contacted me has chosen to remain anonymous. This means he gets the added benefit of being able to choose his own name for when I recount his tale of woe.

I asked him what name he would like to use, and the name he chose was Dumb Moron - I think it is of French origin...

Story Time

So Dumb Moron recently bought a second hand car and put down a R60k deposit for the car. The rest of the car was financed at prime, and around the time of the first debit order he threw an extra R10k into the loan.

Hang on... why is his name dumb moron? That doesn't seem so bad?

The problem is, Dumb Moron paid R250k for this particular second hand ride! He also financed the car over 72 months.

He says his monthly instalment is around R3800.

Dumb Moron has another problem - his commute is around 100km a day (terrible I know, but not something for this blog post...) This makes his monthly petrol cost around R2800 a month (ouch!).

Then, naturally, an expensive car (and yes I do view a R250k car as expensive) has a high insurance premium - in this case a cool R1300 a month.

OK so let's do a monthly total:
Instalment - R3800
Insurance - R1300
Fuel - R2800

Monthly Cost = R7900

That is quite hefty!

There Has To Be Another Way!

But all is not lost, because Dumb Moron realised that by owning this very expensive car he could possibly be....well a dumb moron...

You see after having some fun, his new wheels eventually became just his wheels, and then his very expensive wheels.

This led to Dumb Moron wondering if he possibly made a big mistake and should maybe consider downgrading to something more affordable. So he did some digging and found a decent car for around R100k. This car had the added bonus of having much better fuel efficiency and a much lower insurance premium (sounds promising!)

He then phoned around and found out that he could trade in his current wheels and get around R180k.

So basically he could sell his car and walk away with 0 - the settlement amount on the car loan is also pretty much R180k.

This made him reluctant to pursue the cheaper car option as it would mean saying bye bye to the R70k that he had put in. So he got in touch with me and presented me with his conundrum.

Was it worth it to effectively write off that R70k and get a cheaper car, or should he keep his new wheels?

Oooh goodie, I get to play with some numbers!

Running The Numbers

I initially thought that what I should do is calculate the monthly savings of having a cheaper car, and then work out how long it would take for those savings to reach the R70k break-even point.

But as I was putting together the spreadsheet something dawned on me...

That 70k is pretty much gone - regardless of whether he sells his car or not!

The fact is his current car is worth R70k less than when he bought it - and whether he sells the car now or not, that R70k is gone - so this is not actually a factor in the calculation at all. Once I came to this realisation, it became immediately obvious that the cheaper car was without a doubt the better way to go.

So I guess the question then is - well how much better?

So details on the cheaper car:
Price R100k
Fuel cost = R1400
Insurance = R600

I then assumed a R0 deposit for the new car, and the same 72 month finance term and 10.5% interest rate (this will put his finance payment for the cheaper car at around R1878/month).

So total monthly cost of the cheaper car:
Instalment - R1878
Insurance - R600
Fuel - R1400

Monthly Cost = R3878 (much better!)

Dumb Moron didn't send me his current exact finance numbers, but for the purposes of simplicity, let's  assume that the extra R10k extra he put in on month one of his current cars loan will shave around 4 months off the term of the loan.

From the information given, his expensive car's finance would run to completion at month 67 (72 month term, one payment down, and 4 months less for the extra R10k he put in.) For simplicity I also ignored the potential higher service and parts cost of his current car versus the cheaper car.

I then ran a month by month scenario on a spreadsheet, with month 1 being the theoretical time he got his new cheaper car.

As always, I have sent the spreadsheet I used to the blog's subscribers, if you would like a copy, get in touch and I will swing it. (The spreadsheet is also pretty useful if you find yourself in a situation where you need to decide whether to go for a cheaper or more expensive car - it is pretty good at making you aware what you will be missing out on by going for the more expensive option.)

*2018/01 Update - I have made the spreadsheet available for download on the Spreadsheets page.

Running the numbers - doh!

The long and short of it is that he will be around R4000 better off every month by getting the cheaper car. That's enough to fill up an annual TFSA allocation every year and then some!

I also worked out that at month 18 he will get a warm fuzzy feeling knowing that he has "made back" the R70k he put in extra on the more expensive car (although in truth that money was gone to start with).

After 5 years he would have saved himself close on a quarter million Rand! (I said quarter million coz it sounds way more impressive than R250k :))

At month 67, when the expensive car would have been paid off, the cheaper car is still saving him money every month, even though it is still financed. (Only R200, but cheaper is cheaper...)

After month 72, when both cars would have been paid off - the cheaper car costs around R2000 a month less. By this point the money saved by buying the cheaper car is sitting at around R265k!

So by trading in his expensive car for the cheaper one, Dumb Moron can become Average Moron.

From Average To Smart

Now of course all these "savings" from the cheaper car is only theoretical paper money. In order for Average Moron to graduate to Smart Moron, he should put those monthly savings into an investment, or use it to pay off other debt, or at least do something with that money that will leave him better off.

If he just blows those savings on other "stuff," then has he actually saved anything?

Theoretically he has been able to live, despite having the expensive car, and therefore anything saved by owning a cheaper car should theoretically be available for investing/improving his financial situation? Yes?

I added a column to the spreadsheet detailing what would happen if the savings were invested in something that gave a 15.28% annual return, for example equities - more detail on how I got that number here.

In this scenario, after 80 months he would have around half a million - more than decent!

To wrap this all up - I think it is a no brainer what Dumb Moron should do!

Ditch the expensive car - cheap is the new black!

Till next time, Stay Stealthy!
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