I will never understand the folks who jump from financed car to financed car. As soon as they've paid off their humble wheels, they'll use the extra cash to upgrade to a nicer ride—sometimes with an even bigger car payment than before. In my opinion, when you have a perfectly safe, serviceable, paid-off car, you should stick with it. Because here's the thing: Car payments suck.
If you just think about the cash flow, that couple (or several) hundred dollars you pay towards the loan each month could probably be put to better use paying down other debt or adding to your retirement fund—it adds up quick. But beyond just your monthly bottom line, financing a car is a very expensive endeavor in itself, and most new car loans leave you upside down from day one. This post from Dave Ramsey breaks it down:
Recent statistics show that one-third of car buyers sign up for a six-year loan at an average interest rate of 9.6%. Among these buyers, the average price of the car is just over $26,000. This means that one-third of the cars you see on the road are dragging a $475 payment behind them.
The car dealer won't tell you that your awesome new car loses about 25% of its value the instant you drive it off the lot. After four years, your car has lost about 70% of its value!
What does that mean? After six years, you've paid almost $33,000 for a $26,000 car, which is now worth maybe $6,000. Not a good deal.
"But," I know you're thinking, "I have to have a car to get around. This is just the way the system works." Not exactly. If you're financially minded and have the good fortune of steady income, you can step out of the system and forge your own way, avoiding both interest and steep depreciation in one go. Here's how: Buy a used car, with cash.
Even a car model one or two years old will have already been dealt the blow of "off the lot" depreciation, meaning the amount you paid is going to be much closer to what the car is worth as an asset. The lower price also makes it much more achievable to pay for the whole thing with cash—no interest rates, no car payment.
How to Pay for Your Next Car in Cash
Depending on the car you're looking for, a late model year (with all the safety and comfort features you're after) will still set you back a huge chunk of change. Most people just don't have thousands or tens of thousands of dollars sitting in a savings account that they can sink into a car at the dealership. (And so the circle of financing lives on.) And that's why you shouldn't wait until you're at the dealership to prepare and save for that moment. You can start now.
1. Round up your current car payment
If you're paying off a car loan right now, your first goal should be to pay that off as quickly as possible. One way to do that is to round up your existing car payment to the next hundred, and begin paying that amount towards your loan every month (if your regular payment is something like $399, you might want to add $51 instead of just $1). Depending on how much extra you put in, you could significantly shorten the length of your loan, as well as save big bucks on interest. There's a loan calculator on Bankrate that will help you estimate the impact of extra payments.
2. Keep Making "payments" even when you're paid up
Once your car is finally paid off, instead of sitting back and diverting the extra monthly cash to beer money or a new coffee table, put it in savings. In other words, keep making your $400 monthly payment, but instead of sending it to your lender, send it to a savings account that you've earmarked for your next car. In just a few years, you should have plenty in the bank to roll up to the dealership and choose any (used) car on the lot, like the smart-money baller that you are.