31 Days To Fix Your Finances, Day 29: Paying Cash

The Simple Dollar offers a month-long plan for fixing your finances. All you need is an open mind and an hour each day.

There is one final point that merits discussion before we close out this month, and that is the logic behind paying cash for any purchases smaller than a home purchase. This includes automobiles, appliances, furniture, electronics, and so forth. To most Americans, this concept is almost alien, but if you take nothing else away from this month, this is the concept to remember.

Why pay cash? To put it simply, instead of paying some company an interest rate, you can invest that money yourself and earn some interest. This might seem like a minor issue, but in actuality it is thousands of dollars that you’re throwing away, more than enough to keep companies like GMAC in solid financial shape year after year after year.

How much can I actually save? In this example of a late model used car costing $10,000, you can pocket about $3,000 simply by paying in cash rather than financing the car. That’s how much you will pay in interest, plus the amount that you can earn in interest in a savings account. Do that three times and you’ve literally netted a free car.

How am I supposed to pay cash for a car? The next question that many people ask is how they can possibly pay cash for a car. If you’ve followed this plan from the beginning, the answer should be pretty clear: your emergency fund. If you see that an auto purchase is coming, start rolling money into your emergency fund instead of into other investments or uses, building it up to the point of having several months of salary in it. I recommend making car payments into the emergency fund at this point, preferably for a couple of years. Then simply walk into the dealership, negotiate a price without saying that you’ll use their financing, then write a check. After that, you’ll probably need to build up your emergency fund again, but you won’t be making payments on your car.

I can’t do that right now! That’s true, you probably can’t do that immediately. But you can set it as a goal. One big step towards achieving that goal is to stop leasing, because auto leases as they allow you to effectively rent a more expensive car than you can afford, but leave you with nothing in the end. If you already don’t lease, then buy a late model used and drive it for years past the end of the financing. While that’s happening, continue to make your car payments into your emergency fund. Then, when the time comes, you can simply buy a car, no questions asked.

So what can I take away? Spend some time and plan out when your next auto purchase will be and what type of car you’re aiming to buy. Then, calculate the numbers and see if you can put yourself in place to pay in cash. Can’t swing it? Could you swing it if you drove that car for another year? Remember, this does fit into your budget if you just transform your car payment into payments into your emergency fund, and in a few years the dividends of seeing interest build up on your car “payments” will really start to show.

Now that the month is almost complete, we’ll spend the next two days tying up some loose ends.

Ready? Let’s continue on to the next day.

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  1. Mukesh says:

    Hi Trent, your suggestion to use the emergency fund for purchasing a car contradicts the earlier article (day 15) where you say do not use the emergency fund for big-ticket items, but save it for things like college for son.

    -Mukesh

  2. phil says:

    Shouldn’t your emergency fund remain for emergencies? It seems like it’s better to set up a completely different account (at ING or HSBC or some other high-interest-paying bank) for car savings. I don’t think I’d want to raid the emergeny fund to do this unless you really, really need to replace a dead car right away.

  3. rebecca says:

    Quick comment: it might be better to talk about this pattern of paying in full rather than taking out a loan of some sort as “paying upfront” – because in essentially all of these examples, you’re actually better off if you don’t literally pay cash, but instead pay on a credit card for which you don’t ever carry a balance but for which you eg get cash or points back, and which lets you keep that actual cash in your high-interest-bearing account an extra month….

  4. Dana says:

    We set up an automobile replacement fund that is separate from our emergency fund. This replacement fund is where we save money until it is time to replace the current vehicle. It’s important to not completely deplete that emergency fund. Emergencies seem to happen when you least expect them and when you are least prepared to handle them.

  5. Trent says:

    Rebecca: you’re correct, but in that situation a credit card is essentially the same as paying cash, except you’re racking up some free bonus points.

    Dana: I agree, but some people are really really averse to having a bunch of savings accounts for various situations, simply because it adds to account management time.

  6. Trent says:

    Mukesh: you are correct. In this case, I am encouraging people to “pay ahead” into their emergency fund and then use that as their payment. As Dana pointed out, you’re better off using a separate account for paying ahead for an auto purchase.

  7. Leo says:

    Great post, as always. I’ve blogged about this post here.

  8. Mission Debt Freedom says:

    I use a sinking fund inside my emergency fund. For example if my emergency fund needs to be around $10k, but my car is on its last leg I’ll add another $10k to it and use that cash to buy a new car. You could always set up a separate account as some of you have suggested, however, you will make slightly more compounding interest with the higher balance.

  9. Chris says:

    Mission, while that sounds right, assuming both accounts are exactly the same interest rates, they’ll make the same amount as if they were combined. Two $10k accounts works out exactly the same as a single $20k account. It isn’t the amount in a single place that makes compound interest work, it’s the amount total against the interest rate.

  10. James says:

    My best friend and I had a friendly argument on the topic of car leasing and ownership. I took the same side as Trent. I told him that financing a rapidly depreciating asset such as a car is utter nonsense and that you should simply pay cash if possible. My friend, on the other hand, chooses to view a car lease as a recurring expense for a luxury item which can be budgeted into his cashflows. To him, it is the price for enjoying a nonessential thing in his life, much like the way one might pay $5/mo for HBO or $30/yr for a favorite magazine.
    While I still maintain my point of view (and Trent’s), I think my buddy makes a valid point. I think it boils down to personal preference and priorities. He is willing to pay a (high) price to have new and expensive cars all the time while I would rather direct my money elsewhere.

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