If you have a car payment, you need to get rid of it. As a philosophy of mine I try to avoid anything that requires a recurring monthly payment. I understand some things are inevitable but I want to stress that a car payment is not one of them.From talking to financial counselors many times when people are struggling and broken in their financial life, it is often because they find themselves in a lousy car situation or buying too much house. I will talk about buying too much house later this week, but for now let me stick to the car.
What I mean by a lousy car situation is they bought a new car and have been paying huge payments on it rather than paying cash, and now that they are in trouble financially because there was no buffer for life to happen they find that their car is worth LESS than what they still owe on it.
This happens far too often.
My advice and philosophy on this is pretty simple. I have 2 basic "car rules."
Car Rule #1: Don't buy new. My suggestion and personal philosophy is to get a 2 year old car. The reason for this is strictly numerical. As soon as you drive a new car off the lot it is taking a huge chunk of value off. In fact a large percentage of the value gets taken off in the first 2 years. By buying a car after 2 years you have avoided taking a huge depreciation hit.
Car Rule #2: Make payments to yourself.
Right now I am driving a 99 Honda Accord that does not have payments. Yet I am paying a $350 car payment to myself. There is a reason for this. It is smart. I can either make payments later and have a lot of that going to interest and be making someone else money, or I can make payments to myself now in my money market account that earns 5.05% and have interest coming in. Then when it is time to buy my 2 year old car I will have the money to pay cash for it. Side note: If you have cash you can get a major deal on a car, especially when looking to buy from individuals. When you show them you have cash and can give it to them as soon as they agree that is extremely enticing.
If you are thinking: "But I need to buy a car now but have no money saved up. What do I do?"
I will answer your question by giving you 2 scenarios and you can decide for yourself which is better.
Normally we buy:
$18,000 car; 7 years at 10%; payments of $300; value after 7 years, $800
Or we could buy instead:
$6,000 car; 7 years at 10%; payments of $100; value after 7 years, $400.
The other $200 per month is saved at 10% (mutual fund) for 7 years = $24,190
Now who may the right choice:
At Year Seven
The car is fully depreciated, in either plan, but in the 2nd plan:
Savings $24,190
One year old car for cash <$16,000>
Left in savings $ 8,190
No Car Payments!
Another Seven Years
Saving $300 per month from year 7 to year 14
plus interest on $8,190 (10% return) the car is fully depreciated again.
Savings $52,245
One year old car for cash <$25,000>
Left in savings $27,245
No Car Payments!
Which scenario do you choose?
After 14 years you are in a position where you are set up to never have to make another car payment just because of a decision you made 14 years ago.
It is a shift of thinking from, "I will always have a car payment" to "I never want a car payment."
Use the compound interest factor for your advantage and not against you. It is powerful either way.
