Does it make sense to buy a new used car that gets great mileage, compared to keeping an old heap, thinking that the gas savings will outweigh the cost of borrowing?
Suppose an old family van isn’t needed anymore since the kids are out on their own. It could be tempting to consider alternatives, for example, there is the opportunity to buy a great used car; a Honda CIVIC from a friend for $5,000. A loan will be necessary since debt reduction has been the goal instead of saving for future needs, so will the gas savings be larger than the loan?
The new car in question is a 2001 2 door CIVIC, 106,000 miles, in excellent condition, and can get nearly 40 miles per gallon, since it has the high-efficiency engine and constant velocity transmission.
The van in question is a 1998 Ford Windstar with 165,000 miles on it, and it averages about 17 miles per gallon with its 3.0 engine.
A $5,000 loan at 7% for 36 months has a monthly payment of $154.39. The van gets driven about 700 miles per month, with a monthly fuel consumption of 41 gallons for $144.11 per month at $3.50 per gallon (700/17×3.50). The Honda’s Fuel cost at 35 miles per gallon would be $70 per month (700/35×3.50).
The net result is that since gas savings would be $74.11 per month and the car payment is $154.39, then to purchase the car by borrowing the buyer would be about $80 in the hole.
I have not calculated the residual values of the vehicles, nor have I considered the maintenance cost. On one hand the Honda should be inexpensive to maintain since it is excellent condition and has new tires. However it requires timing belt replacement every 80,000 miles and other regular service that is unknown. The van is in good shape mechanically, but it could die any day or need a major repair, but either way its useful life is probably less than two years.
The only way it would make sense to make the change is if the van needed major service today, or if gas went to almost $8 per gallon, or there is a substantial increased the amount of miles driven.
Since the gas savings doesn’t exceed the car payment, it makes sense to save the difference, buy a car later, and pray for the van to continue to hum along without major repairs.