How to Switch to Paying Cash for Your Car

In 2003, I purchased a 1997 Ford F-150 pickup. Given the financial disaster that my life was at the tiem, I “paid” for it entirely with a loan, which saddled me with car payments for the next three-plus years.

In 2010, the Ford F-150 needed to be replaced, so we bought a 2004 Honda Pilot. This time around, we paid cash for the whole thing. No loans were involved – we just paid cash.

This was a pretty major transformation. I went from an approximately $ 10,000 car loan to paying $ 10,000 in cash for a car. The difference, of course, was a lack of car payments, but it also saved us thousands of dollars. Literally.

Let’s walk through this change and how you can make it happen in your life.

How Much Money Can You Save?

Let’s assume that you’re buying a late model used car for $ 10,000. Current used car interest rates clock in at 4.75% or so. If you get a 48 month used car loan for that $ 10,000, you’re going to be facing a monthly payment of $ 229.16. Over the course of that loan, then, you’ll be paying $ 10,999.68 over the course of that loan. In other words, you’ll just be handing the bank $ 999.68.

On the other hand, let’s say you do this beforehand. You put $ 229.16 into the bank each month – the exact same amount you’d be paying on that loan. That savings account earns a 1% return. After four years, that account will have $ 11,218 in it. Pay $ 10,000 in cash for the car and you still have $ 1,218 in your hand.

The difference between saving up for a car and using a car loan is $ 2,217 for a $ 10,000 car – and this is at a point where the interest rates are about as strongly in your favor as they have ever been. If interest rates on loans ever go up from here, the number is going to get bigger and bigger.

In other words, the practice of saving up for a car and paying cash is going to save you a significant percentage of the value of the car – 20%, easily, and usually far more – compared to taking out a loan for that car.

How Can I Make This Change?

The process is actually pretty easy. It just involves making a few smart moves.

First of all, you should subscribe to the “drive it into the ground” model of car ownership. It is much, much more difficult to adopt a cash-only car buying routine if you’re buying new or late model used cars and quickly upgrading in a few years.

By “drive it into the ground,” I mean that you should keep up maintenance on the car and continue to drive it until it begins to no longer be consistently reliable or repair costs approach the value of the car. Depending on the model, this milestone could be reached anywhere between 125,000 and 300,000 miles (or even more).

Of course, you’ll want to be on the higher end of that range, and the way to do that is to stick with car brands that have a strong reliability record. The easiest way to find that information is to head to the library before your next car purchase and look at recent editions of the annual Consumer Reports car buying guide. These provide a list of different car makes in order of their reliability as reported to Consumer Reports through reader surveys.

So, the game plan is to to drive your current car until you can’t drive it any more. There are a few situations you might find yourself in as you adopt that plan.

First, your current car might be on a lease. Your game plan should be to buy the car at the end of the lease provided that the price is reasonable. This may involve a loan (for now), but we’ll get there in a minute. Note how much your monthly lease payment is.

Maybe your current car is still on a loan. If that’s the case, simply note how much your monthly car payment is.

What if your current car is loan-free? Look back and see how much your monthly car payment was.

In each of these cases, you should have a monthly number in mind. As soon as you are free of payments, you should start paying that amount to a savings account each month.

So, let’s say you have a $ 250 car payment each month. Maybe it’s a lease. Maybe it’s a car loan. Regardless of the reason, as soon as you’re free of that payment and wholly own the car, switch to making those payments to a savings account.

I suggest making those payments automatic, much like your car payment likely already is. Just ask your bank to make a monthly transfer to a savings account for you. Most banks can automate transfers between checking and savings accounts upon request.

When you reach a point where you need to replace your car, take a look at this account balance. That’s what you’re going to be using to buy a replacement car.

You might end up buying a very used car at this point because you’ve only saved for a few years. That’s okay. Just drive this used car for a few years and your account will have built up a healthy balance, plus you’ll enjoy very low insurance rates during that period.

If you truly cannot afford a reliable car due to the low balance of that account (this might happen if you’re buying a car only a few months after starting), take out a car loan for the new car then switch back to paying it off. As soon as this loan is paid off, switch to saving the amount of your old car payment each month.

After the first car purchase completely from the account, you can usually trim back your monthly payment by about 50% or so as long as you stick to the “drive it in the ground” philosophy. So, in the example above, you might trim back your monthly contribution to $ 110 or so. Over the course of eight years, that amount will add up to more than $ 10,000, more than enough to buy a reliable late model used car.

What if you only want new cars? If you’re only going to buy new cars or if you’re only going to drive cars until the 100,000 mile mark or so, you’re going to have a very hard time switching to paying cash up front. The only way you can get there is to save each month beyond your car payment until you have enough in savings to make a purchase and, at that point, you’ll need to seriously bump up your account contribution to the level of your old car payments (or more).

This is a very poor financial strategy, however. New cars – especially anything beyond economy models – are incredibly cost-efficient and devalue rapidly almost as soon as they leave the lot. Similarly, selling off a car before you’re close to the end of the car’s life essentially sacrifices your car’s most financially efficient years. I really recommend the strategy of buying late model used and driving it until it’s no longer reliable as those are the most financially efficient years of car ownership.

Final Thoughts

The entire goal here is to transition to a situation where you can just pay for a replacement car whenever you need it out of your savings account and the account continually builds itself back up because you contribute $ 100 a month (or so) to the account like clockwork.

This is exactly the situation we find ourselves in. We put aside about $ 250 a month ($ 125 per car) for car replacements and we plan to do that as long as we’re a two car household. Whenever we reach a point where we need to replace a car, we’ll just tap that account and use the money to buy a late model used car (or possibly a new economy car, depending on discounts and other factors).

This level of funding enables us to constantly maintain two high quality reliable automobiles. One is an efficient economy car that Sarah uses primarily for commuting and the other is a larger vehicle used for our family needs.

Our goal is to never make a car payment ever again and, with this account and this savings plan, that kind of future looks very possible.

Can you do this? Absolutely. The real key is to just transition your car payments to your savings account once your current car is paid off. If you do that – and you stick with your car for a few more years – your savings account will have more than enough money to pay for it. That’s a pretty good feeling – and it’s one that will help your financial bottom line.

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Big wins: The quickest way to wealth

Note: This article is from J.D. Roth, who founded Get Rich Slowly in 2006. J.D.’s non-financial writing can be found at More Than Money, where he recently wrote about the difference between tenacity and talent.There’s a divide in the world of personal finance. On one side are the folks who offer advice for scrimping and saving your way to financial success. On the other are the experts who scoff at frugality and champion big wins. I think there’s a place for both.From my perspective, it’s important to do the small stuff — clipping coupons, conserving electricity — because doing so builds good habits. And, of course, many small actions combine to yield big rewards in the long term. (Plus there’s the fact …

via Get Rich Slowly – Personal Finance That Makes Sense.:

Note: This article is from J.D. Roth, who founded Get Rich Slowly in 2006. J.D.’s non-financial writing can be found at More Than Money , where he recently wrote about the difference between tenacity and talent.

There’s a divide in the world of personal finance. On one side are the folks who offer advice for scrimping and saving your way to financial success. On the other are the experts who scoff at frugality and champion big wins. I think there’s a place for both.

From my perspective, it’s important to do the small stuff — clipping coupons, conserving electricity — because doing so builds good habits. And, of course, many small actions combine to yield big rewards in the long term. (Plus there’s the fact that a frugal lifestyle costs less to support, which means you can reach financial independence all the sooner!)

On the other hand, the “big wins” camp has a valid point. Too many people focus exclusively on the small stuff because it’s easy to do and doesn’t require any real sacrifice. Yet you improve your monthly cash flow by hundreds of dollars by achieving a single big win, which is likely to be more than you save on all of the thrifty things you do combined.

Big wins vs. pyrrhic victories

The way I see it, there are four types of things you can do to reduce your expenses or boost your income.

• Difficult (or time-consuming) things that provide small pay-offs. These pyrrhic victories include things like going door-to-door to collect old newspapers in order to earn money or making your own laundry detergent.


• Easy (or quick) things that provide small pay-offs. Because there are so many of these opportunities, they’re the bread and butter of personal finance. They’re the daily victories with which we’re all familiar. On the income side, they include working overtime and participating in research studies. Small, quick ways to reduce spending include clipping coupons, buying clothes at thrift stores, and making use of the public library.


• Difficult (or time-consuming) things that provide big pay-offs. Some tasks, such as moving to a cheaper home in a cheaper city, can provide huge rewards, but they take a lot of time and effort to accomplish. These are ongoing projects, and might include selling all of the stuff you’ve collected in your attic or garage. (An example of this is me selling my comic books last year.)


• Easy (or quick) things that provide big pay-offs. Here’s where you should spend most of your time: Working toward big wins. These include negotiating your salary (which takes minutes, but pays off for decades to come) and reducing your transportation costs (which you can do in a matter of days).

Here’s a diagram to provide a visual representation of what I’m describing:

Some actions provide bigger payoffs than others. And some are easier than others.

Note: For convenience, I’m saying that the things we do fall into one of these four quadrants. In reality, all of this exists on a continuum. Some of the easy actions are easier than others. And each of us will obtain slightly different results.

As you can see, big wins are the best way to improve your financial situation. They’re easy (or quick) to achieve, but provide big rewards. If you want to improve your financial situation, start with these.

How to achieve big wins

Here are some examples of common ways to achieve big wins that will dramatically improve your cash flow:

Housing

Housing is the biggest expense for most Americans — and by a wide margin. According to the U.S. Bureau of Labor Statistics’ 2012 Consumer Expenditure Survey (CES), the typical American household spends 32.8 percent of its income on housing, which includes mortgage (or rent), maintenance, insurance, interest, and utilities.

In an ideal world, you’d slash your housing expense by buying an affordable home in a city with a low cost of living. But while that would provide a huge financial reward, it’s not exactly easy, which means it doesn’t qualify as a “big win” in my world. But there are easier ways to reduce your living expenses.

The biggest (and, admittedly, most difficult) is to move within your current city. Sell your home (or move out of your rental) and choose something more affordable. Think about it: If you’re an average American who spends slightly more than $50,000 per year, $1,408 is going to housing every month. Drop that by 10 percent, and you’ll save almost $150 per month. Drop it by 30 percent, and you’ll save more than $5,000 per year!

Transportation

Transportation is our second-largest expense. We spend an average of $750 per month (17.5 percent of the typical budget) to get around, including vehicle payments, gasoline, insurance, and repairs. I know Americans love their automobiles. They’re loath to let go of them, even in the face of logic. But imagine how much you could save if you could cut your car costs in half! How do you do that?

• Sell your current car. Replace it with a used vehicle, one that’s fuel efficient. (Side benefit: An older, used vehicle will cost less to insure!)


• Drive your car only when necessary. When possible, bike or walk to reach your destination. (Side benefit: Increased fitness, which also saves you money!)


• Make use of public transportation. (Side benefit: Time to read!)

Usually when I recommend people make changes to the way they get around, I’m met with a wall of objections. No worries. I’m used to it. But let me suggest that instead of looking for reasons you can’t do this that you instead look for ways you can. You’ll save yourself buckets of money.

Other expenses

Together, housing and transportation consume half of the average American’s budget. There are enormous opportunities to save if you choose to economize on these two categories. But there are dozens of ways to achieve big wins in other areas too.

The CES reveals that the typical household spent $1,736 on clothing in 2012, $3,556 on health care, $2,605 on entertainment, and $6,599 on food (which doesn’t include the $783 that went toward alcohol and tobacco).

Because each of us is different and we spend in different ways, opportunities for big wins vary from person to person. For example, after tracking my spending for the last half of 2013, I realized that I was spending way too much on travel. This year, I hope to cut my travel costs in half. Doing so would allow me to save money toward other goals, such as, guitar lessons.

Examine your own spending. Where do you have the most room to cut back? How can you do it? Look for big wins — and make them happen.

Income

I’ve written before about the importance of increasing your income. While it’s great to cut your spending, you can only trim your budget so far. Your earning potential, on the other hand, is theoretically unlimited. If you really want to get rich — slowly or otherwise — you’re going to have to make more money.

But as with spending, some methods of boosting your income provide big wins while others don’t. Here are two easy (or quick) ways to make a big difference to the amount of money you make:

• Take a second job. Earning more in your spare time is a quick way to boost your cash flow, and it’s something that almost anyone can do. Some people don’t like the idea of taking a second job (they feel like it’s beneath them) and others are full of reasons that doing so is impossible (they don’t have time, the job market is tough). But for those who choose this path, a second job involves less risk and planning than most other income-boosting strategies, and it’s likely to cause far less stress than your primary job.


• Negotiate your salary. One of the best ways to increase your income is at the source: during salary negotiations when you land a job or during a performance review. For many folks, salary negotiations can be awkward or scary. But in his book Negotiating Your Salary, career coach Jack Chapman argues that those few minutes during which you ask for more money in an interview can make a difference of tens of thousands of dollars over your career. Maybe hundreds of thousands. That’s a big win.

There are other ways to supercharge your income — become better educated, start a side business, become a landlord — but they take more time and effort. You can find a second job this week and be earning more toward your financial goals. And you can negotiate a salary increase the next time you sit down for a performance review. Both provide big boosts to your earnings for a minimum of effort.

The bottom line

I’m not saying you shouldn’t make your own laundry detergent or collect newspapers to earn money. But I think it’s important to put these activities in their proper place and to realize that you will never get rich doing them. (In fact, they’re a poor way to get out of debt.) It’s better to focus on actions that are easier to complete and/or yield greater rewards.

The biggest barrier between the average person and big wins isn’t ability. It’s psychology. Big wins generally require effort and sacrifice, which can be tough to stomach, especially if you’re just getting started with smart personal finance. But the sooner you understand that these aren’t fringe ideas, the quicker you’ll get out of debt or reach financial independence. The small stuff forms a great basis for behavioral change, but it’s doing the big things that will make you rich.

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Get Rich Slowly – Personal Finance That Makes Sense.

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Currency exchange is not a hobby for spare cash like it is for some of the people on these boards. I do invest in equities though�. compared to stock markets where there's at least a semblance of regulation to prevent insider …

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