What Is Lifetime Cost?
Lifetime cost is an estimate of how much an item, such as a car, a home, or a piece of industrial machinery, will cost to own over the expected useful life of that item. It also includes cost of purchasing the item in the first place.
- The lifetime cost of an item represents its initial purchase price plus the cost of operating and maintaining it over its expected lifetime.
- Lifetime cost is also referred to as whole-life cost, life cycle cost, or total cost of ownership.
- Lifetime costs can greatly exceed an item's purchase price, making them important to consider in the purchasing decision.
- Opportunity cost refers to what a consumer or business might have gained by using the money for a different purpose, such as investing it.
Understanding and Calculating Lifetime Cost
Businesses will frequently calculate lifetime cost before making large expenditures, upgrades, or renovations. For example, if they are buying a new piece of machinery, they will not only consider what it costs to buy initially but also what it is likely to cost to operate and maintain over its expected lifetime. Lifetime cost may also be referred to as whole-life cost, life cycle cost, or total cost of ownership.
Individual consumers can also find it useful to calculate lifetime cost before buying a home, boat, automobile, or other expensive item. Besides the initial purchase price, lifetime costs can include:
- The cost of maintaining the item in a good or functioning conditioning
- Cost of any insurance to protect the item
- Any renovations or upgrades likely to be required for the item
As a simple example, if a person bought a fur coat, the lifetime cost would include the purchase price as well as the expense of cleaning, storing, insuring, and otherwise maintaining the coat.
Often, the lifetime cost of an item may be far greater than the initial purchase price. Many boat owners, for example, will recognize the truth of the old saying that the definition of a boat is a hole in the water into which you throw money.
In addition to lifetime cost, it can also be useful to look at the opportunity cost of a particular expenditure. That refers to the potential benefits of spending the same amount of money in a different manner, such as investing it.
How Debt Adds to Lifetime Cost
Lifetime cost can also include debt repayments. For example, the lifetime cost of an item financed through a credit card or line of credit (LOC) can be much greater than the purchase would have cost had it been paid for with cash. Unless the debt is paid off right away, the interest and fees on the credit card or credit line will add to the lifetime cost of the item.
The most dramatic example for most consumers would be the purchase of a home. For example, consider a $300,000 home purchased with a 20% down payment and a 30-year mortgage with an annual percentage rate of 7%.
Assuming the homeowner keeps that home and mortgage for the next 30 years, by the time it is fully paid off, they will have paid about $335,445 in interest on the $240,000 they borrowed. Together with the $60,000 they put down initially, the repayment of the loan's $240,000 principal, and the $335,445 in interest, the $300,000 home will have cost them $635,445—or more than twice the original purchase price.
And that, of course, doesn't include all the other lifetime costs associated with a home, such as property taxes, homeowners insurance, and routine maintenance. Nor does it include the opportunity cost of using that money differently.
That's the total amount that Americans pay in credit card interest and fees each year, as estimated by the Consumer Financial Protection Bureau. Using credit cards to purchase items can add to their lifetime cost unless the consumer pays their monthly balance in full.
Real-World Example of Lifetime Cost
Car buyers will often compare makes and models, prices, desired features, and different dealers' financing offers before making their buying decision. However, the cost of the vehicle does not end at the car lot.
Consider the costs involved with weekly gas fill-ups, periodic oil changes, auto insurance, licensing and vehicle inspection fees. Still other expenses may include a roadside assistance plan, car washes, and parking or garage rent.
So, for budgeting purposes, it makes sense to look not just at the vehicle's initial price but at what it will cost on an ongoing basis. Not only are some cars cheaper than others but some may also be less expensive to maintain. It can also be the case that a car that is more expensive initially will be less costly on an annual basis, making it a better buy in the long run. The U.S. Department of Energy has an online Vehicle Cost Calculator that allows users to compare the operating costs of up to eight different makes and models based on how much they drive.
According to the American Automobile Association, the average new car costs $9,282 to own and operate. That includes loan finance charges, gasoline, maintenance, insurance, license and registration fees, and depreciation.
What Is Depreciation?
Depreciation is an accounting method that is used to allocate the cost of a particular item over its useful lifetime. For example, a piece of office equipment that is expected to last for five years would lose 20% of its value every year until it has been fully depreciated. Depreciation is often taken into account in estimating the lifetime cost of an item.
How Fast Do Cars Depreciate?
How fast a car depreciates can vary greatly from model to model. As a general rule, the lender Capital One says that a new car may lose 20% of its value in the first year and another 10% to 15% each year over the next five years.
What Is Residual Value?
Residual value refers to what an asset is worth after it has been fully depreciated for accounting purposes. The item may still be saleable to another buyer, in which case the seller will recoup some of the item's expected lifetime cost. A car, for example, may still have some resale or trade-in value even if you've driven it for quite a few years.
The Bottom Line
Lifetime cost is a useful way to estimate how much a particular item will cost to own and can be especially important in high-ticket purchasing decisions.