Great Tips for Buying a Car

In this episode of Industry Focus: Consumer Goods, Emily Flippen and Dan Kline take on a listener request to do a car buying guide. They explore all the different options available to a prospective car buyer: what you must take into consideration when you're deciding on a car model, what to be aware of when you're getting a loan. Dan also shares his experiences buying cars and much more.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on March 3, 2020.

Emily Flippen: I'm your host, Emily Flippen. It's Tuesday, March 10. Well, for you at least, we're actually pre-recording today's episode, since I'll be out hiking Mount Kilimanjaro on the 10th. But joining me today to talk about a topic actually requested by a listener is Dan Kline.

Dan Kline: I will be doing the opposite of hiking Mount Kilimanjaro. I don't know what that is, but it probably involves me, my couch, maybe Netflix, a video game. [laughs] Like, that is a very bold statement for you to be making.

Flippen: Some will say you are smarter for that choice. I wonder if I'm going to be actually taking advantage of the helicopter insurance I had to buy, because I am not nearly in good enough shape to make it to the top, but I will definitely try.

Kline: Will you be hiring a Sherpa or some other sort of a person to help you get there?

Flippen: Yes, I'm going with an all-female hiking group, actually. if you hike Mount Kilimanjaro, you have to go with a country-approved tour agency.

Kline: Oh, my! This seems very, very dangerous. Well, on behalf of all the listeners, please be careful. [laughs]

Flippen: [laughs] If you don't hear from me again, then assume I'm stuck in Tanzania somewhere.

Kline: [laughs] Yes, if we air this episode and I come back up at the end giving a little speech about you, this will not be great.

Flippen: [laughs] Well, this will be quite the note to go off on. [laughs] I'm not sure if I want this to be my last episode of Industry Focus, but it will definitely be an interesting one. And I like it because it's actually one that was requested by a listener. I read this really nice review of Industry Focus on iTunes the other day, and I did want to give a shout-out to the writer -- that's Dylan from Boston. Dylan said that one of his favorite episodes was actually from you, Dan, when you and Maurie Backman talked about five tips for buying a new home with Nick Sciple. And, yeah, he followed it up with the suggestion that we do an episode about buying a car.

Kline: And that's a good lesson for our listeners. A lot of you interact with us on Facebook. If you post something, even if it doesn't agree with us, as long as it's respectful, we're happy to jump in and have a conversation. We're doing a whole show because someone said, "I'd like to hear a show on that." That is customer service.

Flippen: [laughs] Either that or we're really scraping the bottom of the barrel; one of those two things.

Kline: That's an evergreen topic and you're going away, but we've done this a lot of times, whether it's doing a mailbag show or something we talked about on Twitter. So, really, jump on, interact with us. And Emily is new to Twitter, but she's one of its rising stars. And I'm online; all of our hosts are pretty much there. So, interact, ask and ye shall receive.

Flippen: It's always nice to hear from listeners, especially when you're doing a podcast like Industry Focus, it can feel like you're talking into the void, so whatever means for you to have to reach out to us, be via email whether that be on Twitter, Facebook, leaving reviews. Yeah, we'll definitely read them, we'll definitely get to them. So, yeah, leave those reviews if you have them, but in the meantime, Dan, let's talk about what Dylan really wanted to hear about, which was buying a car, which is a really good question. I think a lot of consumers go through that point in their life where they're having to maybe buy their first car and they have no idea what to do.

Kline: So, I've bought a lot of cars over the years. When I was younger, it was always very inexpensive used cars or a car a friend of a friend was done with, that kind of thing. But now that I'm a little bit older, I'm 46, I've had a couple of different experiences. And about three years ago, my wife and I both bought a car together about three months apart. And when her car was dying, she had ridden my old Hyundai Elantra into the ground, we tried the traditional process.

And many of you know the traditional process. You go to a dealer and the dealer tries to find out from you "Well, how much do you want to spend a month?" And there is the No. 1 lesson, go in with how much you want to spend total, not how much you want to spend a month. We knew we wanted to spend no more than $12,000 on a car.

We went into the dealer and it was a terrible experience. First of all, we had to trade in, and the dealer did the thing where they take your keys so they can evaluate your trade-in. What they're really doing is taking your keys so you can't leave, and I'm not saying every dealer does this, but I've had these enough times. And then, we told the person we would like to buy a used car, preferably one year old, we'll talk about this later, but that's a great way to save some money.

And the person started talking to us and we told him our amount, we said, $12,000. And he came back and said, "Why, I think I can get you into a new one for close to that." And we weren't opposed to a new one. And he came back to me and he said, "Well, we did all the numbers, how about $16,500." And I said, "No, that's not that close." And this went on a few times, with me getting progressively more angry and asking for my keys back on more than one occasion. Until finally, as we were leaving, after more or less threatening them, if they didn't hand our keys back, because we actually had to pick our son up, they came back and they came pretty close to our price.

And the problem is, in my opinion, this model sort of violated the rules of negotiation. If you start at $13,000 and I can get you down to $12,500. That's a fair negotiation. That was you trying to get the best price. If you start at $16,500 and are willing to come down to, like, a little over $12,000, you were trying to take advantage of me. And they could have given me the car and I wouldn't have wanted to do business with them.

So, it started out as a very bad experience. We then went to Carvana (CVNA 3.25%), a company we're going to talk about, you've seen the commercials. The commercials talk about the car vending machine, but the reality is Carvana is a used-car service that will deliver cars to you. I'm not sure if they operate in every market, but here in West Palm Beach, we could see cars that were free to deliver, because they were local or maybe a car that was in Miami or Orlando, maybe with $75 or $150 to deliver.

We put in what we wanted, she wanted a Nissan Sentra, she had already test-driven one, one year old, she had a couple of features she wanted. And we got to pick from four or five. We picked one, and 48 hours later it was delivered. We ended up using Carvana for financing. We had an offer from a credit union or bank or someone else, but Carvana came up with a fair offer. It took about 10 minutes of signing papers and we then had a week or 400 miles to drive it around and if anything was wrong with it -- I think, there was like a trunk latch issue -- they came and took it and fixed it, or if you just hate it, they will take it back and bring you another car. And we asked the person that delivered our car, and she said there are people that do that over and over until they find the right car. So, I believe strongly in, sort of, disruptive models in the car buying process.

Flippen: Well, I'll tell you one thing, if something needs to be disrupted, it is the car buying process. It's not only a bad experience from virtually everybody who doesn't have experience buying a car and goes into it blind. A lot of times, as you mentioned, they get ripped off by dealerships. So, anyone who disrupts that process, I happen to think, is in a good business themselves.

And you got a couple of really good tips in there. The first one being, be aware of the games that dealerships play, if you do go to a dealership. Don't buy a new car, you kind of alluded to that a little bit, about that leaving you open to lose money. And one of the things that I always say, the first thing you should do if you're interested in buying a car, other than figuring out exactly the type of car that you're looking for, is to get financing lined up beforehand. Nothing is worse than going into a dealership or going to wherever you're buying a car and having them negotiate with you on the monthly price and then you find out that you're being gouged in terms of your interest rates.

While it's always better to pay cash for cars, they're depreciating assets. If you need to get a loan, go to your local bank, go to your local credit union, they're the ones who are going to probably give you the best rate.

Kline: Yeah, absolutely. And this is one of those things where you can fall into a trap. So, if you go in and say, "Well, I don't want to spend more than $250 a month," you might leave there with more car than you need and a car loan that's six or seven years long. It used to be that five was the max and now you're seeing six. I don't actually know if you're seeing seven, but you're absolutely seeing six.

Flippen: Oh, you are.

Kline: Okay. So, you end up with something that you may be A., be sick of in four or five years, but might not work anymore, if you're a heavy driver. Traditionally, the max you should take a car loan is four years. And I would say, four years on a car that's one year old, that's very reliable. And you want to work backwards from price, not backwards from payments. So, if you're spending $10,000 total on the car. And you say, "Okay, well, this is what it would cost me a month with a two-year financing. Well, I can't afford that. What if I take it out to three years? Oh, OK, that's a payment I can manage." That makes sense.

But if you just look at the payment, well, at some point you'll end up with a 20-year car loan. And the danger of having a car loan that's long is it becomes tempting to, at some point, trade the car in, owe money on it and take an even bigger car loan. And then you just have this sort of endless cycle of debt, where ideally, you're going to take a two-year, three-year, at worst, a four-year loan, but you're going to drive that car for five, six, seven years, because cars are more reliable than they ever were.

But that brings me to, what I think is the Bible of the car buying process is, the Consumer Reports' Used Car Buying Guide. Buy this when it comes out, they sell out. The new car guide is out right now. I'm not sure when the used car one comes out. You could sometimes find copies on eBay, and the value of this is, besides that they've done extensive reviews, they will show you the maintenance history of that car. So, you might look and see, hey, the Nissan Versa, that's what I drive, is very reliable, but the 2016 one has transmission problems, so maybe I don't want to buy the 2016 one or maybe I do, because it's such a great deal, but I want to get insurance that'll cover my transmission if it falls off.

Flippen: Yeah, that's a really good suggestion.

Kline: Yeah. You want to be really careful and you also should know what the price is. And there are a few ways to do that on used cars. The first is to just triangulate, look at different used car services, places like CarMax (KMX 0.65%), TrueCar, any of your local dealers. And just see, OK, roughly I want a Volkswagen Jetta from 2016 with these features. And on the low end it goes for $11,000, on the high end it goes for $14,000. The difference is mileage and maybe one has the sport package, one doesn't. This is an absolute "do your homework," and it's totally OK to go to a used car lot and just test drive four or five cars to narrow down what you're comfortable in before you do your pricing research. This is an area we have to be comfortable saying "no," you're going to disappoint a lot of sales people.

Flippen: And that's totally fine, because when the tables are turned, I think those sales people might start to disappoint you too when you get to the negotiations. So, that's the value of using a service like CarMax or Carvana or even looking on a platform like TrueCar, is the idea that you might pay a slightly higher price than what you get, if you're actually going to a dealership and you play negotiation hardball, but when push comes to shove, the vast majority of Americans, I would say, culturally, aren't comfortable negotiating. It's something that people aren't accustomed to having to do in their everyday life. And so, they're actually exposing themselves to a lot more ability to be ripped off by car dealerships than they would otherwise.

I personally have never used one of these platforms, but when I purchased my last vehicle, I actually did a similar process. Went online, searched, tried to figure out what vehicles I was comfortable in. When we found one -- obviously, if you have the ability to pay cash, that makes the whole process easier, but for me, it was looking at trade-ins, looking at trade-ins on dealership lot.

So, you know, going to a Nissan dealership and finding a trade-in car that Nissan is having a really hard time getting rid of and then bringing those out for independent inspections is a really big part of the used-car buying process, if you aren't able to get it certified pre-owned.

Kline: Yeah. And it's absolutely important to look at the whole picture. So, I've bought cars from dealers. And my favorite example of getting taken advantage of by a dealer is, I bought a Saturn from, I think, it was a General Motors dealer, I don't know, maybe 24 hours before Saturn went out of business. They knew that was happening, and while technically they were obligated to provide parts for it, the parent company, not the dealer, it became progressively harder to get parts for my car when things went wrong. So I bought something that was even more of a depreciating asset than usual.

But car dealers are not inherently bad, they don't all use this model. So what you want to do is ask around in your community, because if you find a car dealer that is -- maybe they don't play the negotiation game or maybe they're a tiny bit higher, but you're getting free oil changes or loaner cars when they're servicing. Like, you want to look at the total picture. And if there's a dealer that has a great reputation, that's worked with your family and your friends and your neighbors, you might have a good experience there.

The same is true of independent used car lots. In general, a used car lot is a risky way to buy a car. I bought, I think, a 2016 BMW a few years ago, thinking I wanted to drive a fancy car. And there were a lot of hidden things wrong with it that taking it to an external inspection didn't turn up. They had redone a lot of the wiring in ways that weren't factory correct. So, I had problems six months down the road that were really, really significant that weren't caught, but I didn't know anything about this dealer, I didn't ask anybody, I just knew I wanted a certain car and they had it at the right price. Do your homework on who you're buying from and shop places that have a good reputation.

Flippen: You've clearly been around the block with car purchases. I love it. I mean, I feel like you've purchased a car in every way known to man. It seems like your favorite experience thus far has been Carvana. And let's, you know, I guess close the gap in why I'm getting away with talking about this subject today. And that's a lot of these publicly traded companies that are improving the car buying experience, Carvana being one of them, CarMax, obviously being another one, and the platform, TrueCar.

So, Carvana, as you alluded to, is improving the process by moving the entire process virtually online and making it accessible to you. CarMax actually takes a different model. They're also used- and new-car sales from a -- what they call a dealership with integrity, but they have physical locations, way more physical locations than Carvana.

Kline: Yeah. Which, in my opinion, explains why their prices are higher. And again, I have not done a scientific nationwide study, I bought two cars three years ago. And I found while CarMax was, they gave you the price, there were no games, those prices were a little bit higher. Now, that might be worth it for someone who really wants their hands on the car before they buy it, they don't want to deal with Carvana delivers it, then you drive it for a few days and decide you don't like it.

My wife and I are not overly picky, we're not car people. After my debacle with the BMW, I decided I wanted something small, easy to drive, didn't require a lot of maintenance, didn't take a lot of gas. I test drove a few things and landed on the car. She has a Sentra, I have a Versa, both, almost exactly the same car, because we wanted to feel comfortable, interchangeably driving each other's cars.

That worked with Carvana for us, because we found that they had the lowest price, they handled all the paperwork, they brought it to us, but there are lots of other ways. And CarMax, if you're someone who's not comfortable with that virtual world, you might pay a little bit more, but you're not going to have to go through the whole, like, "Well, what's the real price?"

Flippen: What I think is really interesting is that, as a consumer when I look at Carvana versus CarMax, I feel like I would -- and granted, this is coming from somebody who has never used either of those sites -- but I feel like I would lean toward Carvana, because it's an entirely online process. If they have prices that are lower and they're willing to deliver it to me, then that to me, is an improved customer experience.

That being said, when you look at the financials of these companies, so, if you take the investor viewpoint, Carvana has been burning through money for years, versus CarMax, which while not consistently, but has been profitable. So, it's really interesting to me that the company that's taken more of a physical location model, that's kept their prices a little bit higher, has really returned more for investors in terms of profitability than Carvana.

Kline: Well, physical locations cost money, but they're also advertising. You know, you can drive by a CarMax; in most cases, you're not driving by a Carvana. And CarMax locations are huge, they're hard to avoid. The problem with Carvana is, it's largely an online marketing play for a product that has very limited markup. So, you know, they're selling me a used car at a very, very low profit. And in theory, they make money on financing, but their business model is predicated on them not being pushy about the financing. You could take it, you don't have to take it, there are other add-ons you could get; you know, warranties and other things. And they make money on all of those, but they've also made it easy to refuse those or choose to get them elsewhere.

So, as a business, I don't know that I'd invest. As a consumer, I think it's a lovely experience and something I would do. Ultimately, their business model is based on that someday everyone will know who Carvana is and they don't have to spend as much money telling you who they are.

Flippen: Exactly. And you alluded to this, but these companies do make a decent chunk of money, not a majority, but a decent chunk of money from setting up financing for their consumers. And part of that value proposition is not being overly pushy with the financing, the way that a lot of car dealerships are, because that's where they make a lion's share of their money.

But it is to say that they're feeding into what many people have called a car loan bubble. Now, not that Carvana and CarMax themselves are the major pushers for this, but we're seeing car loans, as you said earlier, extending out to run seven years in some cases. With those car loans, with those types of lengths and those interest rates, most consumers will be underwater, guaranteed to be underwater on their vehicle purchases with terms that long. And people have said that we're almost seeing financial crisis level issues here, with the way that people are overextending themselves in a low interest rate environment with credit on cars. I was interested in how you felt at all about this potential, I guess, car loan bubble, if you will?

Kline: Yeah. So, it's a problem and there's a fundamental reason for it. So, I'm married, I'm a 46-year-old guy, I have a 15-year-old. I view my car as a method of transportation and reliability. And how easy it is to use is by far the most important thing. I think a lot of people see their car as a fashion statement. So, if you are spending the money for a luxury brand or something that people think is cool or maybe it's a technology that makes you seem environmentally friendly but you're paying $20,000 more for it than for my very environmentally friendly compact car, you're driving up your price.

And I go back to the advice of, buy the least amount of car that meets your needs. So don't buy a smart car if you have two kids, because it only has front seats and there's only two of them. But I have one 15-year-old, so I bought a hatchback. My wife can sit next to me, my son could sit in the back. If we have to move things to go on a trip, I can put down half the backseat, or if I'm moving stuff on my own, I could put the whole backseat.

Yeah, I got a newer car, because I'm going to drive it for, you know, hopefully seven, eight years, maybe at some point my son will take it from me. But it was the least amount of car that made sense for us. Also, I don't commute to work. I tend to do a 200-mile trip once a month, but then not much driving otherwise. So, really figure out, do I need this 18-seat giant vehicle that eats gas, do I need a sports car, do I need a pickup truck? If you don't need those things, don't buy those things.

This is a place to get rid of vanity, don't care what other people think of your car. If you're a family that has two cars, like my wife and I are; we had the bad luck that both of our cars, sort of, wore out at exactly the same time. Normally, we've always had one newer car that she would use to commute to work and an older car, because I'm just driving around town. On an average day, I might not leave the house or may just go like a mile to pick my son up at the bus stop. So, I don't need a fancy car.

Probably, one of our two cars will way outlive the other, because we use my car just way less, our family trips tend to be in her car. So, at some point, maybe my car becomes her car, her car becomes my son's car, or we sell it used and just be really sensible about it. And any time you can be driving a reliable car with no payment, put that money in the bank, invest that money, that is a bonus to yourself that's way better than being able to say, "Hey, I drive a Mercedes."

Flippen: That's probably the best place to leave off this podcast, in the single bottom-line advice for consumers and investors, don't overextend yourself and only buy what you can afford and what you need, that suit your needs, you know, helps the environment too, one less Hummer on the road. [laughs]

Kline: [laughs] Thanks for having me, Emily. I hope the climb goes well.

Flippen: [laughs] Thanks I do appreciate it. And I'll take that luck. Listeners, that does it for this episode of Industry Focus. If you have any questions or just want to reach out and say, "Hey!" shoot us an email at [email protected] or tweet us @MFIndustryFocus.

As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear.

Thanks to Austin Morgan for his work behind the glass today. For Dan Kline, I'm Emily Flippen, thanks for listening and Fool on!