Driving a flash car? Make sure you can really afford it...
I was dropping my girls to school last week, and en route I was stopped at a red light. There were two lanes on this particular road, one to go straight on and one to go right.
I was turning right and as we waited for the lights to go green, a fantastic new 171 reg car, which was going straight on, pulled up alongside us.
You couldn’t help but admire the car, it really was gorgeous, and when I looked into the driver’s window, staring back at me was a man, and if I was to guess his age, I would say mid-30s.
Our eyes met for a brief second, and then his dropped as he looked back at my 07 car up and down, then sideways, and back at me.
I don't really know how to describe the look on his face, but it was one mixed with pity, hilarity and smugness. The light turned green, one last look at me, but this time he was actually laughing and off he sped in his new car. I didn't react to the green light, I was still reeling from the derisory look he gave me, making me feel for a second that I was driving a three wheel, Rodney Trotter type car.
A car behind me honked its horn and I quickly snapped back into reality and off I went.
If you were to measure someone's wealth and success by the car they drive, then this guy certainly looked the part. To be able to drive and own a car like that, he must be doing really well for himself.
I guess that’s one way you could look at it, or a more jaundiced view might be, why on earth would you want to (a) buy a car so expensive and/or (b) why would you want monthly repayments that probably take up a large chunk of your monthly outgoings?
I come across people all the time where the monthly cost of owning a car takes up a significant portion of their monthly income.
And remember, paying for a car comes from after-tax income so whatever the monthly cost is, multiply it by 12 and then by about 1.5; this multiple will depend on your annual income and that is how much the repayments are really costing you each year.
A client I met last week is paying €783 per month for his new 171 car and in his case €17,724 of what he earns every year has to pay for his car. And that is just the financing costs; add in fuel, tax, insurance, maintenance and it’s more like €30,000.
And if you didn’t finance the purchase by borrowing money because you used your own savings, how bad a purchase and investment is that? Really bad, if the cost is greater than €10,000 because I think the rule of thumb when it comes to how much a car depreciates in value is, that it will halve in value every three years. So, if you bought a car for cash for €20,000, in six years’ time it will be worth only about 5,000.
I checked the price of the car the guy I encountered was driving, and oh my God was it expensive.
I looked at the different ways he could have financed it and I was assuming he had traded in a car so I gave him a really good trade-in value (€20k) and even with that, the cheapest monthly repayment I could come up with was €563 per month and that was at a really low interest rate.
The repayment could have been a lot higher but for the purpose of this exercise I wanted to be overly optimistic and I probably over stated trade in values, interest rates etc. And I was still coming up with a monthly repayment of €563.
At best this car was going to cost him €6,756 every year, and €33,780 over for the next five years.
Because repayments come from after tax income, I reckon it will cost him just under €50,000 in gross income over those five years.
If you divide this number by 1,825 days, the cost of financing this car will be €27.39 every single day for the next 5 years.
If you think about it, it's like getting into your car first thing in the morning, starting the engine, rolling down the window and throwing two ten, and one five euro note out the window every morning along with a two euro coin.
And I would love to have seen this guy’s pension and savings statement and how much might have been outstanding on his mortgage.
Did he realise how much of an impact this car was having on other areas of his finances?
Maybe he did, but I come across people all the time who don't do the math before they take on these types of loans, to see what impact it has on other areas of their finances.
I guess for many it is something they decide to ignore because if you were to choose between a nice shiny new car now versus a five or six-year-old one, the shiny new car will win out.
It wins out because those around you are all driving new cars and you want to be like them, and also there’s no real pleasure saving money into something you won’t see the benefit from for another 25 or 30 years.
And, sure, you will get to that at some stage in the future anyway.
That’s at least what you promise yourself, but we know from research carried out umpteen times in this regard the chances of following through on this promise are not good.
I thought how different this guy’s finances could be in five years if he chose a different route, if you excuse the pun, if he didn't buy such an expensive car and didn't have huge monthly repayments.
What if he didn't have any monthly repayments at all? What if he bought a car like I and others do for cash, and aside from the daily cost of running his car, he would have that €563 to use on something else every month.
What if he saved €263 ever month into a dedicated savings account so that when his second hand car needs to be replaced in five years he would have €15,780 to use?
And the €300 left over, how about he saved that into his pension? It would be like saving €500 each month because he would be getting tax relief at 40%, and if he did that for 25 years, and his annual return was, say, 7%, guess how much would be in his fund...€407,398.
The cost of continuing to own such expensive vehicle over a long period of time is significant.
In this instance if he continued to change his car every five years, and borrowed the same amount, over 20 years, those four cars would have cost him about €198,706 in before-tax income.
If you think that is a big number, add in the opportunity lost by not investing that same money in savings and pension accounts that I just referred to and now the difference is €621,884.
For that amount I really hope he likes his new car.
Liam Croke is MD of Harmonics Financial Ltd,
based in Plassey. He can be contacted at email@example.com or www.harmonics.ie