Friday, January 25, 2008

How saving money can buy you a car


Buying a car (or any other vehicle) is almost a rite of passage. In a way, it says, "welcome to the adult world". I still remember my first vehicle purchase...it was a 1980 Ford F100 pick up truck, two tone red over silver, with an orange pinstripe. I'll always remember that truck. I paid $1200 for it, and I paid with cash, something I had been saving for since I had started my first job. Wish I knew then what I knew now.

You see, I started off right, I bought the truck with cash. I saved my money to buy it, and I saved the interest by not financing it. So far so good, but I stopped there. If I only knew what I should have done next.

Here is what I should have done. If I had continued to save my money, even $100 a month, I would have had a head start down the road, when I needed to replace the truck. But, I was young, and carefree, and I had a truck! I had a whole new world of things to do, open up before me. Well, my truck died, and soon, I was caught in the cycle of car debt...buy a car, finance it, trade it in, roll the balance into a new purchase, and make payments, and on and on.

What I should have done, is kept putting a car payment every month into some sort of investment account. Let's say a growth mutual fund that is averaging 10% (not uncommon). Let's use the average car payment of $400, and a term of 60 months, as that is the most common here in the US. Let's use a current finance rate of about 7.5% for a used car loan. Well, you look at the payment and the term, and you think, "Gee, a $24,000 car for $400 a month, that's not bad..." Wrong, because of interest, to get that $400 payment, you'll only be getting a car that sold for $19,500. So you just lost $4500 worth of car you could have bought, because of the interest payment. Also, don;t forget, this cost did not factor in sales tax, registration, title and inspection fees, either.

What if you bought a clunker (or as we like to say where I live, a "hooptie") paid in full with cash, and you saved that $400 a month for 60 months. Right off the bat, you've got that extra $4500 that would not have gone to interest. But if you had invested those monthly payments in that growth mutual fund at 10%, you would have about $32,000 at the end of 5 years. There is quite a bit of difference in car you can buy with $32,000, compared to $19,500...$12,500 more.

But, it can get better! What if your still really frugal, and you buy a nice, used vehicle at $20,000 cash (and you can negotiate some great deals when you hold a wad of cash in front of someone). That will still leave you $12,000 in your growth mutual fund. Well, pretend you have a car payment, and keep adding it to the mutual fund each month. In another 5 years, you'll have about $51,000 ready for your next car purchase. What kind of car can you get then? Say you splurge, and buy a used vehicle at $30,000...it still leaves you with $21,000 in your fund. Follow the process one more time, and you'll have about $66,000 for a car. Now, you'll never have to pay for a car again. Why? First, keep buying your cars in the mid $20,000 range (you can get really great used vehicles at that price). If you keep $40,000 in that fund, and never add to it after that, every 5 years you'll be back to about $66,000. Also, keep in mind that you will have a vehicle to trade in or sell, as well, which will bring you several thousand more dollars.

In a nutshell, you've saved tens of thousands of dollars in interest payments you would have otherwise paid the bank, you earned some great returns on your investment, you've had some nice used vehicles, and in 15 years, you would have saved and invested enough money that you'll never have to use any of your own money again to pay cash for a car. And this with money you would have been spending anyway, for something you need. So the next time you go to buy a car, ask yourself if you can wait a while longer, and start putting that money into an account that will make you some money...and head down the road to never paying for a car again.

2 comments:

SoNn said...

This is a great idea. Maybe I should also start setting up a "car fund".

Steve said...

Sonn, thanks for stopping by and commenting. I find it exciting to find ways to change the perspective on something we do anyway (car payment), and turn it to our advantage. Let me know how the car fund works out for you.