Dave Ramsey will tell you that “taking on a car payment is one of the dumbest things people do to destroy their chances of building wealth.”
Buying a new car or leasing a new car is extremely “normal” in our society, and a lot of my friends have been asking my advice on this lately. So I am going to discuss here why “normal” is not always good when it comes to buying a new vehicle.
Paying cash for a car?
What’s the method for paying cash for a car? You could put that $500 car payment in a savings account instead for ten months and you could purchase a $5000 used car. Or save for 20 months for a $10,000 used car (I bought a used Honda Odyssey for $6k and an Accord for $12k).
If you’ve read The Millionaire Next Door, you know that the average millionaire drives a second-hand car. Why? It’s because people who are careful with money are not going to buy something that loses over half its value in the first four years. So even if you are paying 0% interest on a car loan, the new car deal is still costing you big time.
What about Leasing?
I have leased one car in my life. Consumer Reports and Smart Money magazine think that leasing a car is the worst way to get a car, and Ramsey calls it a “fleece”. We all get killed financially every time we lease.
Leasing is the car industry’s largest money-maker because, even though you are technically renting the car, the dealer is also charging you interest. So your monthly lease payment not only covers the loss of the car’s value as you drive it, but it includes hefty interest that you pay a new vehicle. After fees that exist that are not even disclosed, I estimate that the average interest rate is 14% to lease. Then there are the charges for going over the allotted mileage and the penalties for “excessive wear and tear,” which they supposedly get you for every time.
As I have mentioned in previous posts, I used to own a Porsche Cayman. It was the one material object I owned that I really loved. I bought it used when the economy crashed (it had 7777 miles…cool!). I had a car payment on it, of course. When I decided to sell my stuff and ditch my debt, the car had to go.
The most interesting part of saving and paying cash for a car is this: If I want to save and buy this car for cash someday, I have to save $40,000, which is $500/month for almost 7 years.
I don’t know about you, but…
If I save up $40,000 and see that cash in my bank account, the chance of me handing it over for a car is VERY SLIM.
At this point in my life, I would probably buy a $10,000 used car and hold on the other $30,000 for:
- My kids’ college
- Home improvement/repair
- My next 3 cars!
This was a real epiphany for me. If I wouldn’t give up cash for a car, why would I finance it PLUS interest?? It’s because when you don’t see the money leaving, it doesn’t hurt. We are so used to financing stuff easily that we have become numb to the actual math.
Right now, my family has created a savings account for our next car. We put our “car payment” in it each month. If I can get 2 more years out of my Odyssey, I can sell it for $3,000 and take another $5,000 or so out of savings to buy another “new” used car. Wash, rinse, repeat forever.
For more on how to save money on cars, there is Dave Ramsey’s video Drive Free, Retire Rich. Or if you are thinking of saving even more money by bypassing the car completely, read How to Live Well Without Owning a Car.