Are you planning to purchase a car but are flummoxed by the variety of options available in the market? Not only are manufacturers launching new models every few months, the changing ownership patterns have also led to growth in the used-car market.
So, which car should you purchase – a new car that is low on maintenance costs but high on insurance expenses or a pre-owned car that offers you an array of higher-end options that fit within your budget but might require greater maintenance? The best way to take this decision is to consider the opportunity cost of each of these alternatives and find out which benefits you more.
Here is a handy guide on some of the important factors you should consider while evaluating the opportunity cost of new and used cars that will help you in making the best choice that suits your needs.
What is Opportunity Cost?
Opportunity cost is the loss of potential benefits an individual or business incurs while choosing one option over another. While opportunity cost is not expressed in terms of monetary value, you can estimate it using the following formula:
Opportunity Cost = (Returns from forgone option) - (Returns from chosen option)
While making a decision, the utility of your chosen option should always be greater than the opportunity cost for it to be the best choice.
Opportunity cost is a great way to compare or arrive at a decision while making your next big purchase like a car.
Let us check out the opportunity cost of new and used cars to decide which option best fits your needs. Here are some factors you should consider before you make the final decision.
Let us assume that a new car will cost you Rs 6 lakh whereas you can purchase a second-hand car that is an older model for Rs 2.5 lakh. This will translate into savings of Rs 3.5 lakh if you opt for the used car, which you can then invest in a fixed deposit for a certain rate of interest.
Therefore, the opportunity cost of buying a new car would Rs 3.5 lakh plus the amount of interest earned on the fixed deposit.
Also known as the cost of ownership, this includes the cost of fuel, spare parts, repairs, insurance, and financing.
While buying a used car may seem attractive due to its lower acquisition cost, the maintenance of such a car can rake up bills with extensive repairs and need for spare parts. You also need to spend higher on fuel due to lower mileage. On the other hand, maintenance costs for a new car will be relatively lower.
Another major cost that you should consider are the insurance costs involved purchasing a car. Although a new car loan offers various incentives, a second-hand car loan helps you save plenty on loan interest rates. Adding to it, cheap insurance premiums balance the other higher costs incurred on the car, therefore, adding to opportunity cost.
Compare the models
You must have set a budget to purchase a car. If you decide to purchase a new car you will be restricted to a certain type and model that you can afford. On the other hand, opting for a second-hand car can expand your choices since you can now select from a range of higher-end models that you can get for cheaper.
Depreciation is the silent killer of any new vehicle. A new car is subjected to higher depreciation in its first three years and the value of the car reduces by almost 50%. As depreciation is calculated using the diminishing balance method, the depreciation of a used car is much lower compared to that of a new car. Also, it will give you a reasonable resale value without significant loss.
There are always hidden costs and consequences in every financial decision and calculating the opportunity cost can help you uncover that. This will aid you in making financially sound decisions that will limit your opportunity costs and maximize your benefits.
Opportunity costs help you find value in choosing one alternative over the other. This will help you understand how much you can earn if you invest the difference in cost between the two options.