Three years ago, gasoline in the United States cost a little more than $2 a gallon.
That seemed high at the time, but it didn't stop many car buyers from purchasing an eight-cylinder SUV or six-cylinder sedan. Now that a fill-up can cost $80 or more, those 2005 buyers might be thinking of trading down to a new, smaller vehicle in the hope of saving money.
They may want to wait a few more years.
Even if gasoline hits $5 a gallon, the savings at the pump are unlikely to make up for the cost of buying a new vehicle featuring better fuel efficiency, according to a recently published study by Consumer Reports magazine.
The review of various trade-in scenarios "shows that it's less expensive to tough out another year or two with a gas-guzzler than to trade in too early."
For example, the Consumer Reports study shows that at $3.75 a gallon for gasoline, an eight-cylinder 2005 Chrysler 300C sedan costs 70 cents per mile to operate, compared to 84 cents a mile for a four-cylinder 2008 Nissan Altima. That 20 percent different exists even though the Chrysler 300C gets 16 miles per gallon compared to the Altima's 25 miles per gallon.
Those figures are based on 12,000 miles driven in the next 12 months and assume the purchase of a new vehicle rather than a used one. The study is available online at ConsumerReports.org.
The two factors that drive the finding that often it is cheaper to keep a gas guzzler than trade down to a more fuel-efficient vehicle are auto-loan interest costs and depreciation.
Interest charges account for the bulk of a monthly payment in the early years of a loan and decline over time. That means if you trade in your vehicle a fraction of the way through the repayment period, the balance owed could still be quite high, even higher than what you owe on the loan. That would leave you with little or nothing to put down on a new, smaller vehicle.
Depreciation, the second factor behind Consumer Reports' findings, is the value an auto loses over time. That happens most rapidly during their first few years as the value of the vehicle plummets by thousands of dollars each year. Consumer Reports estimates that depreciation accounts for 48 percent of an owner's total costs in the first five years, while fuel costs account for about 21 percent. Depreciation levels off after about three years.
If you drive your vehicles for years after they are paid off, then depreciation is not much of an issue. But if you're looking to acquire a new vehicle after just three years, you will get whacked by a trade-in value that is lower than you expected.
That combination of high interest charges and greater depreciation in the early years of new car ownership makes it difficult to argue in favor of buying a new, smaller car.
"Making that change forfeits the benefits of longer-term ownership, lower average annual costs," Consumer Reports says.
The magazine found that trading in for a smaller car begins to make sense after five years.
To reach its conclusion, Consumer Report compared larger and smaller vehicles within individual categories: family sedans, large sedans, SUVs and pickup trucks. It assumed vehicle owners would trade down within the same category, say from a large SUV such as a Chevrolet Tahoe to a small one like a Toyota RAV4.
It took into account total ownership costs, including fuel costs, depreciation, interest charges, insurance, repairs and sales tax.
The analysis involved two gasoline-cost scenarios: $3.75 and $5.00 a gallon. Trading down to a smaller vehicle does not make financial sense even at $5 a gallon, the analysis found.
Even a trade-down that more than doubles fuel mileage is unlikely to pay off within the first three years. For example, the Consumer Report figures show that a 2005 Ford Five Hundred Sedan with a V6 engine that gets 21 miles per gallon costs 51 cents a mile to operate compared to 74 cents a mile for a 2008 Toyota Prius with its 44 miles per gallon.
A great unknown, however, hovering over the Consumer Reports analysis is the impact $5-a-gallon-or-higher gasoline would have on the depreciation rates of large vehicles. If gasoline prices continue to spiral upward, auto dealers may offer even less than they do now for larger trade-in vehicles. That could change the equation on the best time — if ever — to trade down.
The bottom line is that right now, says Consumer Reports, it makes more sense to sit tight.
David McPherson is founder and principal of Four Ponds Financial Planning (www.fourpondsfinancial.com) in Falmouth, Mass. He previously worked as a financial writer and editor for The Providence Journal in Rhode Island. He is a member of the Garrett Planning Network and the National Association of Personal Financial Advisors. Contact McPherson at firstname.lastname@example.org
This work is the opinion of the columnist and in no way reflects the opinion of ABC News.
David McPherson is founder and principal of Four Ponds Financial Planning (www.fourpondsfinancial.com) in Falmouth, Mass. He previously worked as a financial writer and editor for The Providence Journal in Rhode Island. He is a member of the Garrett Planning Network, whose members provide financial advice to clients on an hourly, as-needed basis. Contact McPherson at email@example.com