With the rising cost of fuel, vehicles such as the Hummer H2 have been lagging in sales.
With the national average gasoline price hovering at about $4 a gallon, many consumers are trading in their larger vehicles for smaller models with better fuel economy. While that is a good goal, making the switch too soon could cost you more in overall owner costs than you'll save at the pump, according to a new Consumer Reports study. It is clear from reviewing our car owner cost data that downsizing pays off in the long run — as long as the timing is right.
It's understandable that many drivers want to cut their fuel expenses and reduce their negative effects on the environment as quickly as possible. In fact, recent sales figures show that sales of large SUVs and pickup trucks are down dramatically, while small cars and hybrids are gaining popularity.
General Motors' Hummer division, for example, announced that sales were down more than 45 percent in April 2008, compared with the corresponding month last year. Meanwhile, U.S. sales of the Toyota Prius hybrid jumped almost 54 percent over the same period.
But CR's study shows that it often doesn't pay right now to downsize if you've only owned your vehicle for three years. Because of the trend in consumer downsizing, we have explored the potential costs of keeping a fuel-thirsty, 3-year-old vehicle versus the potential costs of trading it in for a new, economical car. In the tables on the following pages, we present the estimated owner costs of both options over the next 12 months to illustrate the financial impact of each.
OWNER COSTS VS. FUEL SAVINGS
Ultimately, the hidden costs of car ownership might be the factors you are least likely to focus on when driven to downsize, but they can have a major effect on your finances down the road. Two important factors to consider when trading in for a new car: your finance charges and the cars' depreciation.
Consumer Reports' study shows that if you still owe on your vehicle loan, then it might not be worth downsizing to a smaller vehicle after only three years, even if the new car's fuel economy is much greater. Remember, with a traditional loan, interest makes up a larger percentage of your monthly payment initially, scaling down over time. Consequently, less is paid to the principal of the loan in the first year than the last. If you trade in part way through your loan period, you may find you have less equity, or trade-in value, in the model than expected — limiting the potential down payment on the new vehicle.
The other main hurdle affecting your car's equity is depreciation, or the value a vehicle loses over time. According to CR's owner-cost estimates, depreciation makes up, on average, about 48 percent of an owner's total vehicle costs in the first five years. Fuel costs are only about 21 percent, on average. And the greatest depreciation occurs in the first three years. After that, depreciation begins leveling off.
So, if you trade in a 3-year-old vehicle, you begin the wild depreciation ride all over again with the new vehicle — rushing from the most expensive period of ownership into the same phase in the next vehicle. Making that change forfeits the benefits of longer-term ownership — lower average annual costs. On the other hand, if you've owned your car for four or more years, that initial depreciation is amortized over a longer period.
So, according to CR's analysis, the amount a typical, payment-making owner could save in fuel costs by trading in early at three years, even with a big jump in miles per gallon, is significantly less than the amount the person will save in depreciation by keeping the vehicle another two years. After five years, trading in for a smaller car makes more economic sense.
