One of the personal finance practices I use is to pay cash for my cars. After a house, a car is generally the largest single expenditure that is made. Thus, a car is also the largest opportunity for me to reduce spending. Paying cash causes me to spend less when buying a car. (For more coverage on the cost of cars and the impact on personal finances, see recent articles in MSN.com and Yahoo! Finance.)
However, it is often easier to spend more, versus less, when buying a car. One reason is that the cost can be spread out over 4 to 6 years of monthly payments. At a loan rate of 7%, the cost of an extra $1000 is between $17.05 per month (for a 6 year loan) to $23.95 per month (for a 4 year loan). It's easy to justify a premium stereo for "only" $17 to $24 a month. That's barely the cost a meal. The salesman knows that, the finance manager knows that, and the buyer knows that. Before long, one is paying about $200 more per month to get a car that cost $8000 more.
For me, the solution is to get the comparison back to the real numbers. That's where paying cash for a car helps. It puts the decision on the real money difference, not the monthly difference. It's not $24 a month more for a premium stereo, it's $1000. For $24, I barely think about it. For $1000, I think hard about it and pass. Paying cash causes me to ask the question, "Do I really need that?" when considering car options.
So how can one save enough to buy a car? It's easy if one is already making a car payment. The secret to keep the car several years after it is paid off AND keep making "car payments" to one's savings account. Thus, after 5 to 6 years, there is enough money to purchase the next car with cash.
Here's an example of how it can work. After paying off the car loan in three years, I continued to make "car payments" to myself. Because I kept the car for 10 years, I made $232 "car payments" to a savings account for 7 years, resulting in over $19,000 saved. That money was used as a cash payment for our next car.
For more on The Practice of Personal Finance, check back every Wednesday for a new segment.
Photo Credit: morgueFile.com, Daniel T. Yara
However, it is often easier to spend more, versus less, when buying a car. One reason is that the cost can be spread out over 4 to 6 years of monthly payments. At a loan rate of 7%, the cost of an extra $1000 is between $17.05 per month (for a 6 year loan) to $23.95 per month (for a 4 year loan). It's easy to justify a premium stereo for "only" $17 to $24 a month. That's barely the cost a meal. The salesman knows that, the finance manager knows that, and the buyer knows that. Before long, one is paying about $200 more per month to get a car that cost $8000 more.
For me, the solution is to get the comparison back to the real numbers. That's where paying cash for a car helps. It puts the decision on the real money difference, not the monthly difference. It's not $24 a month more for a premium stereo, it's $1000. For $24, I barely think about it. For $1000, I think hard about it and pass. Paying cash causes me to ask the question, "Do I really need that?" when considering car options.
So how can one save enough to buy a car? It's easy if one is already making a car payment. The secret to keep the car several years after it is paid off AND keep making "car payments" to one's savings account. Thus, after 5 to 6 years, there is enough money to purchase the next car with cash.
Here's an example of how it can work. After paying off the car loan in three years, I continued to make "car payments" to myself. Because I kept the car for 10 years, I made $232 "car payments" to a savings account for 7 years, resulting in over $19,000 saved. That money was used as a cash payment for our next car.
For more on The Practice of Personal Finance, check back every Wednesday for a new segment.
Photo Credit: morgueFile.com, Daniel T. Yara
This is not financial advice. Please consult a professional advisor.
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3 comments:
I like your approach better than Ramsey's "drive free" stuff. :)
I'm a "pay cash-buy used" kind of guy. The car I drive now is an '05 Cadillac Deville. The price paid new (by a leasing company) was $46K. I got it 24 months later for $20K. It only had 20K miles, and 30K left on the bumper to bumper warranty. A private buyer had bought it from the leasing agency, and needed to sell it for health reasons. I paid cash (and because I'm in AZ, there was no sales tax.)
If you read books like "The Millionaire Next Door", you'll find that this is common practice among smart money people. If you figure in interest, tax, etc, I saved about $30K. Compound the interest over 5 years (at 10%), and I net $48K!!! That profit sure helps me get over not having "that new car smell"!
Don't buy the hype of the car dealers and the money lending machine! Financed new cars are for suckers!
better pay cash rather than using credit cards.. this article is so helpful and useful and i love reading it..glad that i have seen your blog
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