debt

To the reader: I wrote this story in 2000 to illustrate why it is important to weigh the cost of items before buying them. I know that some of the prices may not reflect today’s prices, but if you read the entire story, the thought process still applies.

Have you ever thought that some particular purchase would save you money? I often hear people talk about how they can save money by purchasing something that will save them in other ways. A good example of this is a custom home theater system. Many of my movie buff friends, awed by snazzy displays in electronics stores have convinced themselves that there is virtually no cost in this type of purchase. After all, it is difficult to find a first run movie theater that sells tickets for less than $6.50 each and many are substantially more. Surely, they reason, at say $8.00 per ticket, they would save money purchasing this system that attempts to approximate the theater experience. Is this really the case? Let’s weigh the cost!

One particular friend purchased his system in stages. First he purchased the large screen television for a cost of around $2000. Then he purchased a mid range stereo system including a DVD player for another $2000. For these prices, surely the stereo would include speakers, but says my friend, that is not the case. He spent another $1500 purchasing speakers and a sub woofer because he likes the bass. My friend was telling me how he got a great deal because he purchased several of the components at once. He asserted that he “saved” several hundred dollars on the equipment and that the entire system would pay for itself since he would no longer incur the cost of seeing theatrical releases.

Considering his assertions, my curiosity got the best of my and I began crunching numbers. I added his equipment costs and figured that his system cost $5500.00. At $8.00 per movie, that means he would have to watch 688 films on his home theater before it would pay for itself. Not bad, you might think. He might see that many films in two years if he watched one every day. Of course, this assumes he is watching films that he would have seen in the theater but chose to view them on his home theater instead or else he wouldn’t be saving money. My friend found that even with his home theater, he did not want to give up theatrical movies all together, so maybe it would take a little bit longer for the system to pay for itself.

What my friend never figured into his numbers was that he was going to have to have DVD’s to watch on this new system. At the purchase price for DVD’s, suddenly it would be cheaper for him to watch a movie in the theater. His system could never pay for itself. My friend decided that he would instead rent the DVD’s from the local video store, where DVD’s rent for about $4.00 each. If all of the DVD’s he watches are rented, he only saves $4.00 over the price of watching the film in a theater. This means that we have to do the math all over again. Now for the system to pay for itself (dividing the $5500.00 system by the $4.00 savings), my friend would have to watch 1375 movies for the system to pay for itself. He would have to watch at least one movie every day for close to four years before the system pays for itself. Now my friend is serious about movies, but lets face it, one movie every day is a lot of movies.

My friend never considered that after a couple of years, the technology would be so much better that he would want a new one. Sure his system was great, but look what they have now. Still, the system has not paid for itself so he must press on. He never considered that if he had simply paid the eight bucks to see a theater movie every day that he would be $3000 ahead at this point and not in hock for this stupid home theater. Heck he could have gone to the theater AND bought popcorn every day!

What makes it worse is that my friend bought his system at one of those electronics stores with the 1 year same as cash. How can you beat that – no interest! What he didn’t know was that if the balance isn’t paid off by the end of the year, that the company charges all of the interest back to the date of the purchase as if it was never “same as cash”. To add insult to injury, the credit company charges 29% interest on purchases. That means that in addition to the $5500.00 my friend paid, he also has to pay $1595 PER YEAR interest until it is paid off. If he only pays the minimum payment of $150 per month, it will take him 91 months (7 ½ years) to pay off the system. The total cost of the system is then $13647 including $8147 in interest. This means that including the $4.00 savings per movie, he will have to watch 3412 movies before the system pays for itself. That is a heck of a lot of movies. If my friend watched a movie every day, it would take him more than nine years for the system to pay for itself. In this case, my friend could have paid full price to watch movies every day at the theater for more than nine years. In fact, the system is not really paying for itself if my friend would not otherwise have actually paid the $8.00 every day for nine years to see that many films. It also does not take into consideration that most people see at least SOME movies in discount theaters. If my friend would have seen a film in a discount theater, he would actually be spending more for each movie he chose to view on his home theater.

What I have not mentioned here is that my friend works a job that pays him $20,000 per year. If he pays cash for the system (NOT using a credit card), he will have had to work over three months for no other reason but to pay for his home theater. If he uses a credit card, he will have had to work for more than 8 months to pay for the system. Now, I don’t know about you, but if I could take 3-8 months off of work and still live at the same standard of living, I would rather do that than go to a job and work more for someone else so I can “save” money purchasing a home theater that might not pay even for itself for nine years.

I am not saying that home theaters are bad. I am simply saying that you should carefully weigh the cost of something before you purchase it, considering all things that affect the price. I personally would not purchase such a system when I can see a film in glorious Technicolor on the big screen as it was meant to be seen (in 2.35:1 wide screen of course). If you feel that it is worth it to you to spend the money on such a system, it is your prerogative to spend it on whatever you wish to spend (keeping in mind that you must want it more than that other thing you can’t afford after you have bought it). So go enjoy the movie! And say “Hi” to the ticket taker for me!

If you need help trying to figure out how to weigh the cost of things you’re considering buying, you might want to check out Dig out Of Debt and learn more about how to keep more of your money.

Michael from Wilmington, NC asks: When should you get rid of an old car that is paid for and buy a newer one that would hopefully have less maintenance cost. I am assuming the new car would be paid for outright without credit expenses.

Michael Answers: That is a good question. We recommend buying cars outright with no credit debt and then driving them until they die completely or until it is no longer practical to keep them. When we buy cars, we like to pay cash and we generally pay $2000 to $6000 for the newest low mileage used car when can find. Our last two "new" cars were a 1991 Buick Skylark we bought in 1998 with 50,000 miles for $2500 and a 2000 Ford Taurus station wagon with 59,000 miles we bought in 2004 for $6000. We paid more for the Taurus because it was only four years old, it was in really good shape and we thought it was worth paying a little more for the car Tawra and the kids would be using regularly. (We also hoped it would last a little longer than some of our previous buys).

When we buy a used car, we usually choose well enough that it needs very few repairs in the first year or two. Generally, we expect to pay regular maintenance costs (new tires, oil changes, brake pads, etc.) no matter what car we drive, so we usually don’t count those expenses as "repairs". We will continue to drive the car, making regular repairs until we begin to get the sense that its life span is coming to an end. When we do have to make repairs on a car, we consider it reasonable to spend several hundred dollars a couple times a year to keep it going. This might include replacing a water pump, doing major brake work or general engine work.

Usually, a catastrophic repair (like a new transmission or a new engine) is the death nail for one of our cars since our purchase price for a replacement is usually low. Occasionally, we will fix a catastrophic repair if the car rarely needs work and if we have not had the car very long. Here’s an example where we did that:

Once we received a used car as a gift from family after I crashed a car on an icy road. Two weeks later, the transmission failed. Since the car was new to us, didn’t cost us anything and seemed to be OK otherwise, we went ahead and spent $2000 to fix the transmission.

Most of the time, a car needs only occasional repairs, but over time, the frequency of repairs increases. When it seems that the number of repairs is on the rise, we try to figure out whether or not we think it is a trend. If so, we think of the car as "on its way out" and stop making unnecessary repairs. If we have decided that a car is "on its way out" and it requires a single repair over $500, we will usually consider it dead and replace it. If the car that is a short timer needs several lesser repairs over several months that begin to add up to a lot of money, we will usually get rid of it and get something else.

We had a 1991 Buick Skylark that was a good car for a long time. We originally bought it for $2500 in 1998 when it had 50,000 miles on it. Until 2004, it needed only occasional repairs, so we didn’t feel too bad if we had to put $300 into it from time to time. In 2004, the repairs seemed to come more frequently and we began to think that the car would need to be replaced soon.

We still continued to do regular maintenance, but avoided spending a lot of money on repairs that were not critical. We got a crack in the windshield that was a little bit annoying, but since it was only around the edges and Kansas law did not require us to replace it, we decided not to repair it at the time. Again, we were pretty sure the car was on its way down hill. The heater started to occasionally smell like anti freeze which made me think the heater core was going to fail in a year or two. We started to notice that the paint was peeling from the rear fenders, but because we didn’t think the car was going to last a long time, we decided not to re-paint the car. We still made some regular repairs, but eventually, the car had a brake failure that was difficult to put a price on. We had already spend $500 in the previous 3 months for regular repairs above general maintenance and it appeared that the brake problem could cost another $300-$400. At this point, we decided that the white car had exceeded its useful life, since we would have spent $900 in just a few months if we repaired it and we would still have had a car with a cracked windshield, a dying heater core, peeling paint and other problems that we had not yet discovered.

You will want to consider where your car is in it’s useable life. If you want to keep your expenses low, always remember that a car’s basic purpose is to get you from place to place reliably. You can keep more of your money if you’re not driving the car to impress other people. We usually try to keep the cars looking presentable, but we normally go for clean "plain Jane" cars that run well. All major systems should work well. We live in Kansas, where the temperatures are often over the 100° mark in the summer, so we think that Air Conditioning is a must. When we lived in Colorado, we considered it more of an "option".

When it is clear that a car no longer fulfills it’s basic purpose: to get you from place to place reliably within a reasonable budget, it’s time to get another one.

You are wise in considering a newer "used" car when you replace an older car. Usually, you get the best buy on a car that is new enough to need few repairs, but old enough to be relatively inexpensive. You have to shop around to make sure that you find a good used car with no signs of trouble and it is wise to have a mechanic check it out of you don’t know much about cars.

We try to stick to cars with 60,000 miles or less that appear to have been well maintained and cost between $2000 and $6000.

For Readers considering buying "New":

Brand new cars cost more than they are actually worth, so it’s best to let someone else take the financial hit of being the first buyer of a car. Some people buy brand new cars expecting to "save" on maintenance costs and repairs, but all cars require occasional maintenance and repairs and parts for new cars tend to be more expensive.

The "white car" cost us $2500. We drove it for 8 years, so it cost us $312.50 per year. We averaged $300 per year for repairs, so our total cost for the car was $612.50 per year. Thats PER YEAR, NOT PER MONTH. A similar car purchased new costs $446 per month. That is $5352 per year or $26,760 after five years of payments. Buying used, we saved $4852 per year or $24,260 for the entire cost of the car.

If you still think the new car is worth it, don’t forget that the new car will cost you more in insurance and registration fees and after two years, you will probably be putting money into repairs on top of your monthly payment. It’s something to think about.

photo by: twodolla