Happy Budget Tuesday everyone. Has anyone ever asked you how much you paid for something, like a car? When you answered did you tell the person the sticker price or did you tell them the total price? In reality most of us will automatically give the sticker price without thinking about it twice. Somehow so many people do not take into account financing cost when thinking about how much something cost. Yet it is common to finance so many of the things we buy, either by credit card or loans. I would like to share a conversation I had with a friend to illustrate this concept.
A couple of years ago my friend Sara and I were having dinner with her daughter Hayley, who is in her early 20’s. My friend was celebrating a birthday and I was driving so that Sara could have a drink with dinner. When I arrived, Hayley noticed that I drive almost the exact same car as her mother. We both have 2012 Hondas; the difference is mine is the hybrid version.
During dinner Hayley was talking about how her car was getting to the point that it was unreliable and was thinking of getting a newer car. She likes the Honda her mother and I drive but she wanted to know how much the hybrid version cost. My immediate answer was $26K. I emphasized that I paid cash but Hayley is not really understanding my point.
Next Hayley asks Sara “Mom how much did you pay for your car? It was only $24k right?” Sara says “Yep, I paid about that much.” Keep in mind I know that Sara financed her car because I helped her create her budget. So, I tell Hayley “That is not really an exact comparison. Your mom has a loan on her car and by the time she pays it off she will have spent more than $24k.” Not wanting to give away information Sara would rather not share with her child I give Hayley some rough numbers for the average car.
Given the average interest rate on a car loan of 4% over 5 years, Sara will have paid $27,340. In other words, she spent $3,340 in interest…if she paid the average. With bad credit it only gets worse from there. I also point out to Hayley that a hybrid usually has a bigger price difference but I got a good deal because the dealership wanted to get the old model year of the lot. Why say this? Well I wanted to point out that the car does not have to be the newest one on the lot, you can still get a good value and reliable at the same time.
Flash forward about 6-9 months and I see Hayley driving a brand-new Honda car; same model as her mom and I only the current year. As we begin talking about her new car and how happy she is to have reliable transportation. She begins to share some details with me. Spoiler alert, I am about to have a figurative heart attack over the numbers.
Hayley does not have the best credit and she wanted all the upgrades in the car so the sticker price alone is more than I would have recommended in her situation. The car cost aprox $30k over 7 years at 18%. OH MY GOODNESS, did you just say 18%. YEP. Here are the real numbers for this choice. The total cost of the car will be $52,965; for a whopping total of $22,965 in interest. The interest alone is nearly the sticker price of her mom’s car. Hayley’s car payment is over $600 a month. To this day if you ask Hayley how much she paid for her car she will say $30k.
The question becomes, is it really worth paying $52K for this car? Only my friend’s daughter can answer that question because the answer will be different for each person. My answer would be no. I love my car but not enough to pay that much for it.
The real takeaway from this week’s money discussion is when considering financing a purchase we need to take a look at total cost, not just sticker price. Then evaluate if the cost is worth the value anticipated from the item. If the cost is worth it to you by all means spend your hard-earned money how you want. If not, keep shopping until you find the intersection of cost and value for your comfort level.
The names have been changed to protect privacy.