This is the second part of a two part article about when you should replace an older vehicle rather than repair it. The first part can be seen here (and probably should be read first).
As we reveal more and more factors to evaluate when deciding to either keep or replace one’s vehicle, it is becoming clear that the actual immediate up-front cost of a single repair bill, right now, is only one part of a total set of considerations.
We should be looking at the total cost of ownership, both of our current vehicle and of any other vehicle being considered as a possible alternate solution. This also has the benefit of changing our focus from a fuzzy perception of the unknowable future, to a broader mix of factors, many of which are accurately known and can be predicted. We also need to consider this over some period of time, rather than taking a snapshot right now, so as to even out the good and bad months and occasional repair bills.
We also pointed out in the first article that the largest cost of all, and one that varies enormously, is a cost that is often overlooked or ignored entirely – depreciation. There are two elements to depreciation, and we only touched on one of them in the first part – the gradual reduction in the resale value of your vehicle as it gets steadily older. Let’s now consider the second type of depreciation.
Depreciation Part Two – Mileage Based Depreciation
What causes the value of your car to drop – to depreciate? It isn’t just age, it is also the miles it has been driven.
The typical depreciation formulas of a certain percentage reduction in value each year assume a typical number of miles being driven. If you drive fewer miles, the vehicle will drop less in value, and if you drive more, it will drop more quickly. If you’ve ever leased a vehicle, you’ll know this because your lease allows you so many miles a year, and if you exceed that allowance, will charge you somewhere between perhaps 10c and 30c for every extra mile you drive. This isn’t just the leasing company profiteering at your expense – it is a fair reflection that the vehicle will be worth less at the end of the lease because it will have a higher mileage on it.
(Insider Tip 1 : If you drive fewer miles than the lease allowance, you may have created what is called “lease equity” – at the end of the lease, the car is worth more than the lease buyout. You can use this as a bargaining tool if getting a replacement car from the same dealership. In theory you could buy the car at the lease buyout price and then sell it at the market price, but rather than go to that value, many dealerships will “do a deal” with you to apply the lease equity to a new transaction.)
(Insider Tip 2 : If you think you’re going to need to drive more miles than the lease allows, negotiate a larger mileage allowance or a lower cost per extra mile before signing the lease. You have a little leverage at that point, no leverage at the end of the lease.)
(Insider Tip 3 : If you know you’re going to drive more miles than the lease allows, one way to avoid paying a penalty at the end of the lease is to simply buy the vehicle at the buyout number. If you do that, there’s no charge for the miles. This may or may not make sense to you, but be aware it is an option.)
Back to the main point of this section – mileage based depreciation. It is very difficult to assess how much every mile costs you in depreciation charges, but there are some things to consider.
One technique is to decide how many miles the vehicle will last before being scrapped. There are lots of quotes on the internet in the last few years saying “a typical passenger car should last 200,000 miles”. Other quotes about car longevity talk about the average lifespan of a car being almost 12 years. This article includes both statements.
But within each statement, you’ll see the conditional terms “should” and “almost”, plus also the vague concepts of “typical” and “average”. We could discuss the underpinning uncertainties and assumptions, but perhaps best just to acknowledge that both numbers are extremely approximate, and while they might be vague fuzzy averages, there are very many cars that last much longer and also very many that last shorter (especially those that get written off after accidents).
Could you however take both these statements at face value? Divide the original purchase price of a vehicle by 200,000 and that shows you the car’s cost, amortized over all those miles. You could also divide the original purchase price by 12 and that shows you the cost per year of ownership (assuming it is a steady amount every year, it isn’t).
Take, for example, a $40,000 car.
Cost per mile = 20c if 200,000 miles driven
Cost per month/year = $280/$3335 if 12 years
A problem with these two numbers is they aren’t consistent with each other – a typical driver drives 12,000 – 15,000 miles a year, so a car with a 12 year life would be expected to have 144,000 – 180,000 miles driven during its life. My sense is the 200,000 mile claim is “aspirational” rather than a statistical reality, and also the miles driven per year varies greatly from person to person. This is an excellent article which breaks down typical mileage driven by gender, age, and state.
Another factor is that some types of vehicles get driven more than others. Luxury vehicles get driven less, for example, because owners typically have multiple vehicles.
Let’s keep the 12 year typical life, but assume 13,500 miles driven each year, which brings us to 162,00 miles for an average vehicle’s lifespan.
Cost per mile = 24.7c if 162,000 miles driven
To get a more meaningful average, you should look at figures for your particular state.
If you want to, a bit of Googling might also get you to statistics on the average lifespan of your particular car.
As a general rule of thumb, once you know the regional average miles driven a year, you then know that if a car has fewer miles driven in a year than the average, its value will drop more slowly, and if it has more miles driven a year, its value will drop more quickly. But the cost or benefit of each mile more or less driven won’t be the same as the depreciation cost per mile, it might be closer to perhaps half that.
If it was exactly the same as the depreciation cost per mile, then you could have a six year old car with zero miles still worth full sticker price, and you know that is never the case. You could also have a three year old car with its full theoretical lifespan of miles on it, and theoretically worth nothing at all, but in real life, still worth plenty of money.
(Insider Tip 4 : We like buying nearly new but high mileage vehicles. Assuming they are not commercial or taxi vehicles, this implies they have been used for long journeys and there is typically much less wear on a vehicle when it is fully warmed up and simply cruising along the freeway for hour after hour after hour, than there is for a car in city driving – lots of stop and go short journeys, the engine never really fully warmed up, lots of braking, and so on.)
The purpose of this lengthy discussion is to help you understand the depreciation-related costs of ownership of your present car and of any proposed new car as well.
How Old a Car Should You Buy?
This is a question that has been asked countless times, and answered differently on every occasion. The underlying unstated question is perhaps more exactly expressed as “Is there a time when the market cost of buying a car is appreciably less than its remaining value-in-use”?
When you see the question posed that way, there should be a reflexive desire to answer “No”. In theory, the used car marketplace is “efficient”, which means prices reasonably closely reflect values. If there were particular “sweet spots” where there was a large disconnect between price and value, an efficient market would see the price adjust to close the gap.
However, having said that, we do accept there is an “irrational” extra hit of depreciation for new cars, and so that suggests a mild opportunity to buy a nearly new car.
This can be theoretically shown in the following two charts. The problem with making these charts is that different sources quote widely different expectations for the rate a new car depreciates at, over its first some years. Some sources suggest a three year old car has dropped 40% in value, others suggest more. Some sources suggest a five year old car has dropped 60% in value, others offer different numbers. The truth is much more complicated than any of these rules of thumb, and the actual numbers vary by car make/model and by region, and also by the state of the economy. Sometimes there is more money out there, or special incentives, that encourage people to buy more new cars, other times, people cut back and keep their cars longer and replace with used cars.
Another variable is leased cars. If there are lots of cars being leased for the same amount of time (and lease terms can vary in length), then sometimes there are large numbers of leased cars all being released into the market at the same time, causing a temporary drop in used car values.
But for the purposes of analysis, let’s see what happens if we use a model that has 20% loss of value in the first year, then 15% loss of value (on the reducing remaining value) for three years, and slightly more in subsequent years, showing a drop of 42% after three years, 51% after four years, and 60% after five years. And let’s compare that with a “straight line” model where the car’s total “life” and therefore total value gets consumed evenly each year. If we use a 12 year total lifespan, that creates a pair of curves something like this.
The gap between the blue “theoretical market price” and the orange “remaining value-in-use” lines shows the varying amount of buying opportunity.
If you look at the two lines, you might observe that from about the third year through about the eighth year, the difference remains much the same, before closing in the final years of a vehicle’s life as both curves inevitably move towards the same almost zero scrap value of the car.
But that perception is not altogether correct. Sure, the dollar difference remains about the same, but it becomes an increasingly larger percentage due to the reducing actual dollar amounts. We show this in the second chart.
If this second chart is to be trusted, the best time to buy a car, at best value, is around nine years or so. But does that make sense?
If you feel uncomfortable at this statement, you are very astute, and now is the time we circle back to our original topic – total cost of ownership.
Yes, It Is All About Total Cost of Ownership
Sure, the depreciation cost per year drops on an older vehicle, and also sure, there’s more “remaining value” in an older car’s purchase price than in a newer one, but the other parts of total cost of ownership are changing too. Repair costs are increasing, which should be biasing us back towards newer cars.
The last year or two or three of a vehicle with a 12 year economic life are – by definition – going to be marked by steadily rising costs and compromises that are making the continued ownership of the vehicle no longer justifiable. Sure, if you bought the car many years ago, you might give it “the benefit of the doubt” and continue to own it all the way to the 12th year and possibly even on beyond (remember the 12 year point is the average, not the ultimate number of years – about half of all cars continue to be owned and driven beyond that point). But would you really want to buy a nine or ten year old car, and already be at a point where you were regularly having to shell out substantially for expensive repairs? Probably not.
So, from that perspective, and noting how unpleasant it usually is to buy a used car of any age, perhaps you should look back to a point where the absolute dollar difference is as wide as possible, and there’s still a good half dozen or more years of remaining good life. That suggests to us a sweet spot in the 3 – 6 year range. Many sources recommend buying in that sort of age range.
There’s a particular appeal for some vehicles in that age range – they might still have some remaining amount of their original warranty period. That can greatly reduce your worry that you’re buying a vehicle with concealed problems that will immediately start costing you large sums in repairs. Let’s look some more at ways to limit your risk of buying a bad used vehicle.
Certified Pre-Owned Vehicles
Whether the original warranty has expired or not, there can sometimes be a special type of purchase arrangement – buying a “certified pre-owned” vehicle from a dealership. These vehicles claim to have undergone an extensive maintenance check, with many problems detected and solved, and usually come with some type of warranty as well – either a limited warranty because the original warranty has expired, or an extension of the original warranty (although perhaps not on the exact same terms and with the exact same broad coverages – be sure to check the fine print). We take the “extensive maintenance check” with a grain of salt, but we like the extra warranty, and even if there isn’t any extra warranty, you can credibly complain if, soon after purchase, a CPO vehicle has a costly failure in a component that was allegedly inspected and certified as okay.
You don’t get nothing for nothing, of course, so there is usually an added cost to buy a CPO vehicle rather than a regular vehicle, but this extra cost varies widely between different vehicles. If the price differential is small and the added benefits are large, maybe it makes sense to spend a bit more up-front to buy peace of mind and hopefully lower repair costs for the year or so ahead.
Talking about warranties, you might also be offered an extended warranty that will give you some type of coverage for some years/miles after the original warranty expires. Are they a good deal?
Most experts advise against them. They point out that the warranties include a lot of profit for the dealership or source selling them and need to also make a profit for the warranty company too, so on average, it is fair to say each $1000 of warranty premium is probably buying, well, maybe $600 – $750 of expected coverage.
But those criticisms are essentially true of any type of insurance at all, and there’s also another factor to consider. Some of the warranty companies have negotiated lower costs from the repair shops that work with them. The repair shop might agree to drop its hourly labor charge, might agree to reduce the number of charged hours, and might agree to reducing the margin it makes on replacement parts.
It is easy to see how such negotiated discounts could lower the actual cost of a repair by 10% – 20%, maybe even more if the warranty company drives a hard bargain. In such a case, the price/value equation shifts, and now you are saying “I spend $1000 on warranty premium, but the $700 in budgeted repair costs they expect to pay out would actually cost me $850 if I paid for them myself”. The extra cost of the warranty has reduced, and you might consider that peace of mind and freedom from the fear of a sudden $5000+ engine or transmission job is worth it.
Personally, I’ve generally bought extended warranties, and I have always felt that I’ve made a profit on them. Statistically, that is unlikely, of course, but in my case perhaps I’ve been “lucky” (if you can call having lots of repairs lucky!).
A Surprising Risk when Repairing an Older Vehicle
If you remember back to the hypothetical scenario at the beginning of the first article in this two part series, we wondered what you should do if your car is worth no more than $5,000 and you’re staring a $10,000 repair bill in the face. Repair or replace?
The risk is that if you decide to repair (as we did, ourselves, when confronted with this exact question), you drive out of the repair shop, having left a $10,000 payment behind, in a vehicle that is now worth only $5,000. That’s not normally a problem, especially if you’re planning on keeping it for some more years, but what happens if, as you pull onto the street, you are hit by an oncoming car and after the crash your vehicle is written off by your insurance company? You will not get your $10,000 back. If you’re lucky, you’ll get $5,000. And if you’d had the accident while driving the car to the repair shop, you’d probably have got $2,500 or more back. So the $10,000 investment in your vehicle’s future has resulted in a sudden net $7,500 loss to you.
Of course, hopefully you won’t immediately have an accident, so the risk is low, but maybe it has to be factored into your repair/replace decision.
The reason for the low insurance payout is because of how insurance companies calculate the amount they reimburse you when a car is written off. They’ll pay you the car’s “actual cash value”, ie, a number more or less reflecting how much you’d get for the car if you sold it a minute before the accident. That amount starts off assuming it to be an average car for its age, but does somewhat take into account the car’s condition, wear and tear, problems, blemishes, and so forth. But as you hopefully already know, the $10,000 in repairs, while valuable to you and hopefully making sense in a total cost of ownership calculation over several years, does not add $10,000 to the car’s actual immediate cash value. This article has a very helpful explanation plus some good advice about how to get the best outcome you can.
Calculating Total Cost of Ownership
We suggest that rather than trying to come up with theoretical numbers and rules of thumb, you should actually drill down into the specifics of the actual costs of your current car and possible alternative cars you are considering. Almost certainly, the results will surprise you.
The ownership costs vary so enormously from each make/model to each other one, and also depend on the age of each possible vehicle, so the only meaningful way to consider this important issue is by trying to create reasonably accurate estimates for the specific cars you’re considering.
We also suggest you calculate the respective costs not just for the next year ahead, but, if you can, perhaps for two or three years. Sure, you could go to any number of future years, but the further into the future, the more speculative your numbers become, and we think three years is probably enough to establish some numbers, differences, and trends.
All other things being equal, the answer to your question “should I repair or replace my vehicle” can be answered by looking at these numbers. Of course, it is rare that all things are indeed equal; on the other hand, if you’ve done a good job of trying to cost into your model both the tangible and intangible aspects of each vehicle choice, maybe the numbers are a helpful guide.
Generally, when we do this, we see two possible outcomes :
(a) One of the possible choices is clearly very much less expensive than the others and so should be your preferred choice
(b) There’s surprisingly little difference in the numbers between the different choices, in which case, well, toss a coin? Stick with “the devil you know”? Have another look at the numbers and see if any need to be tweaked and slightly adjusted?
(c) As our worked example, immediately below shows, be alert for how there might be a flip over the years of ownership – the more expensive vehicle in the first year might be the less expensive vehicle over three years.
How to Calculate the Total Cost of Ownership
There’s no magic way of doing this, and it surely calls out for creating a spreadsheet so you can do a series of “what if” calculations. Here’s an example of a spreadsheet we created – click this link to see a somewhat squashed picture of all four pages that of course appear in normal size in the spreadsheet, and you can use the categories and results we’ve chosen as a way of designing your own spreadsheet if you like.
We’ve populated it with our own guesses for what if we continued with our present 2006 Landrover LR3 for three more years, compared to what if we replaced it with about a 2016 Landrover LR4 instead. As you can see, to start with, keeping the LR3 is less costly, but by the end of the three years, the LR4 depreciation has reduced, making it probably less costly into the future.
We’ve saved this spreadsheet, in the older Excel .xls format so as to make it most compatible for most people and programs, and it is available as a download for our very kind Travel Insider Supporters.
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So, almost 9,000 words after we first posed the question at the start of the first article in this two part series, should you repair or replace an older vehicle when confronted with a repair bill greater than the value of the vehicle itself?
The short answer – it depends. As we’ve copiously covered, it is distortingly simplistic to view this issue only in terms of one repair bill right now. You need to consider the past and likely future, and you also need to consider what the true and total cost of both this and alternative vehicles would be.
I hope that I’ve at least outlined the questions you should be asking – not all of which allow for general answers in an article such as this, and explained them so you can come up with specific answers for your situation. In particular, the spreadsheet helps walk you through some of this and gives you at least some type of indication for if you should lean more towards repair or replace.
It is possible I’ve overlooked some considerations. By all means please suggest additional points in comments.
This is the second part of a two part article series. Please also visit the first part of the series here.