Drive-in banks were established so most of the cars could see their real owners. – E. Joseph Crossman, American businessman
The Car Buying Process
We established in an earlier post that we should avoid going in debt to purchase items that depreciate, or lose value over time. Cars depreciate very quickly yet most of us, including myself, still go in debt to purchase them. The usual process for buying cars is:
Buy Car → Pay for Car.
We need to flip this to:
Pay for Car → Buy Car.
How can we flip the car buying process? I propose a three-step plan of:
- Minimizing the amount of car loans;
- Shortening the duration of car loans; and,
- Saving for your next car by paying yourself car payments after the current loan is retired.
Minimizing the Amount of Car Loans
If we are not careful cars can be the ultimate big hat item (purchases that give the appearance of wealth while preventing us from creating real wealth). We need to see cars as a transportation tool, not a status symbol. So how much can you afford to spend on cars and still have a reasonable chance of building wealth?
I like the rule of thumb taught by Dave Ramsey. His rule is that the value of all the cars you own should be less than half of your annual income.
For example, if your Annual household income is $50,000 the value of all cars owned by the household should be under $25,000. Following this rule will keep you from spending so much on cars that you can’t afford other more important things.
Shortening the Duration of Car Loans
The second step is to make the duration of your car loans as short as possible. Cutting a year or two off the standard 5 or 6 year car loan can make a big difference in the amount of interest paid. Perhaps even more important, it will allow you to start saving for your next car a lot sooner.
Cutting the duration of car loans is much easier if you followed step 1 by minimizing the amount of the loan. If you are already locked into a 5 or 6 year car loan there is usually no need to refinance. Simply pay as much extra as you can afford in order to pay the current loan off as soon as possible.
Save Enough to Pay Cash for Your Next Car
After you pay your car off, what should you do with the “extra” money? If you’re like me there is no shortage of options. Perhaps the smartest choice is to keep making the car payment, only pay yourself instead of the bank. A few years of this and you will have enough money to pay cash for your next car.
This might entail driving your current car longer than you are used to, which will undoubtedly lead to extra spending on repairs. The money you are saving for your next car makes a nice emergency fund to help pay for these repairs if necessary.
Flip the Process
Paying cash for cars should be a goal of everyone, and it is not as difficult as it appears. All you have to do is flip the process by minimizing what you spend on cars, shortening the duration of car loans, and paying yourself car payments after loans are retired. It takes a plan, and some discipline to follow through, but the payoff, financially and in peace of mind, can be huge. So start flipping.