#20: Automotive Purchases

25 Rules to Grow Rich By

This is part of a series in which we re-evaluate Money Magazine’s “25 Rules To Grow Rich By”. One “rule” will be re-evaluated each weekday until the series concludes; you can keep tabs on the action at the 25 Rules index.

Rule #20: The best way to save money on a car is to buy a late-model used car and drive it until it’s junk. A car loses 30% of its value in the first year.

Here’s another rule that I almost completely agree with. Late model used cars are the best deal on the market, because they’re almost always cars that have seen their 24 or 36 month lease end while the buyer jumps up to a new car under another lease. Quite often, they’re in great shape, haven’t been driven all that much, and are set to be used for many years.

There is one minor quibble I have with this rule, though, and that’s the general suggestion to just “buy” such a car. Many people take this to mean that you should go to the dealership, pick out your car, and get a good deal on financing. In fact, what you should do is go to the dealership, pick out your car, and pay cash for it.

How do you do this? Once you pay off your car, keep making payments on it. Instead, put those payments in an account where you can’t touch them for a while. Keep driving your car until it’s junk, but keep making “payments” on them into a separate account. Eventually, your car will be ready for the slag heap.

Let’s say, for example, that you bought your car in January 1995 for $12,000 and thus had $300 payments for four years on it, so you sent in your last payment in December 1998. You kept making payments on the car, putting them into a savings account that bears 4% interest (you can easily beat that, but we’re using a low number here). You finally give up on your car in January 2006 and head to the dealership, where he offers you $1,000 in trade for the old car. How much of a car can you get right then and there, paying cash, and never having a payment on it? Try a $30,000 car… you can get a pre-owned Lexus free and clear, or pretty much anything else you might want.

A little bit of planning ahead completely changes the nature of the game. Let’s rewrite that rule.

Rewritten Rule #20: The best way to save money on a car is to pay cash for a late-model used car and drive it until it’s junk. A car loses 30% of its value in the first year.

You can jump ahead to rule #21 or jump back to rule #19.

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  1. John says:

    I added your site to my blog roll earlier this week and have really enjoyed it so far.

    One question I have about what your suggesting is this: how does this work if you are using the debt snowball method?

    Example: My wife and I currently have two car payments. The debt snowball method says that when I finish paying off the first car I push that payment and whatever else I’m paying on the other one all towards that other car. Then, when we finish paying off the cars, push that sum onto the next big debt (in our case, our house).

    I’m not sure how you could do both.
    Any thoughts?

  2. Trent says:

    This is pretty easy, actually, John. If you’re using the debt snowball concept, once the car is paid off, leave it on the list of debts, but move it to the bottom. Then continue to make the minimum payment on whatever your car loan was, but instead of shipping it off to whoever loaned you the car, sock it away in a high-interest savings account. This way, when you finally do need a new car, you won’t incur a new debt.

  3. Joseph says:

    I like the concept of saving money, but I just put down $1200 on repairs to my car. The car drives well and only 5 years/100k miles old, but isn’t the first time I’ve had to put down a lot on repairs. It happens at least twice a year, so my car is payed off but I am spending about as much on repairs as I would be on payments, and if I bought a late model used car like you suggest I may save a lot initially but then the repairs would start rolling in again.
    Or do I just have a lemon?

  4. chris says:

    Joseph,

    You’re just paying too much for repairs. You either need to shop around for a good mechanic, go to a friend who may be a competent shade-tree mechanic, or actually turn a wrench yourself.

    I taught myself how to work on cars and now I’ve managed to made tens of thousands of dollars (seriously) in my spare time be doing something that I actually enjoy (sometimes more than others). While you’re not going to be able to dive straight into a tranny rebuild at your first attempt and the tools are an up-front cost as well as a $10 Chiltons manual, there are innumerable resources available online that cost nothing.

    I can say that a person of average intelligence, ability, and work ethic can easily make a considerable sum by either repairing their own vehicle or others. If you want to get the big bucks, you can start buying ‘broken’ cars and fixing them on your own. I made a profit of $7K on an outlay of 3K over a period of 3 months work on a single car. The beauty of it was that it was a simple engine swap and most of the my time investment was finding a buyer for the car when it was finished.

    I think of this as ‘flipping’ for people who don’t have the capital to buy a house.

  5. carlos barquin says:

    Hi. I really enjoy your site. Let me tell you a little bit about my situation. I’m just moving to the states. So I don’t have any credit history what so ever. I want to buy a car and I have enought money to spend it on buying the car that I want in cash ( honda civic). However my friends keep telling me that I should take advantage of the credit that everybody here uses credit and that I’ll be very stupid if I don’t. Also that if want to start creating a credit history the car payments is a very good idea.

    Now I’m confused. I know I can get probably the monthly payments but probably with a very high interest rate. What would you do?

    Thanks

    Carlos Barquin

  6. sfninersfan says:

    Hi Chris,

    I disagree with your calling it a “simple engine swap”. I’m a pretty handy guy, and I do some DIY projects at home– but I would not want to attempt to swap a car engine. I guess it’s all relative, according to one’s skills.
    I think the average car user would not have the skills to do major repairs like these. Probably about 1% of the population have even done a major car repair on their own.

    Joseph, I feel your pain. I had a 10 year old car that was starting to have some serious problems. So I decided that instead of paying 2k to fix it, I would rather put the 2k towards buying a new car.

    I got a new 2007 corolla for 17k. Payment is about $330 a month. I financed it because it gives me more flexibility. I pay as I go. Yes I know that paying cash will save me money, but I dont think it’s a good idea to use up 17k. I think it’s smarter to finance it instead.

    Paying Cash is not a good idea.
    For example, lets start with I have 18k in the bank. I want to buy a car. So I pay 17k for the car, I have 1k left. Suddenly I lose my job, then I only have 1k to live on. So I lose sleep and stress about how to support my living. Do I need to sell my new car? Then I dont have a car to drive around, to go to interviews, etc.

    Financing:
    I start with 18k in the bank. I want to get a car, so I finance it, and pay $330 for the first month. Suddenly I lose my job. Luckily I still have 17k in the bank. So I can start looking for a new job, and have 17k to pay the rent, food, gas for many months.

  7. Athena says:

    As far as paying cash for your car, if the only reason you are not going to is because you are afraid you will lose your job and you won’t have the money in the bank, I think the intent is that you would have a 6 month Emergency fund in addition to the 17K for the car. If 18K is your 6 month Emergency fund, then you haven’t really saved up to pay cash for a car.

    Another option is to pay cash and start paying yourself the $330 back and have it earning interest for you and if you are about to lose your job, quickly sell your car to yourself or your spouse and take a loan out for it at that time.

  8. nick says:

    If you put money aside for a new car someday, and are making 4% interest on it per year, then you should finance the new car if you can get financing for cheaper then 4%. Lets say your investment makes 4% per year, and the car loan is 3%. By getting the loan, you still end up making 1% every year. Compare this to paying cash, in which you gain a car, but lose all the cashflow. If the financing situation you net a new car, and 1% ROI per year. In the cash example you net a new car, and nothing else.

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