Plan Ahead for a Car Replacement (46/365)

When Sarah replaced her first car (an old Toyota Celica) with her second car (a Mercury Sable of about 1999 vintage), she was financially unprepared for the switch. She had only the tiniest of down payments and had to take out a very large loan to cover the purchase. We ended up paying about 30% more on the car just in interest.

When Sarah replaced her second car with her third (a Toyota Prius), we had plenty of cash in the bank to cover the purchase. Although we panicked at the last minute (we had never paid that much in cash for something before and we kept envisioning these disaster scenarios that would happen after spending the cash) and got a loan, we ended up paying it off in full a month or two later (and we should have just paid cash to start with). We paid virtually no interest for this car.

When I replaced my first car (a Buick Skyhawk of 1984 vintage) with my second car (a Ford F150 of late 1990s vintage), I was financially unprepared for it. I had only a small down payment and had to take out a loan for most of the purchase. We ended up paying about 20% more on the truck just in interest.

When I replaced my second car with my third (a Honda Pilot), we had enough cash on hand that we just wrote a check for it. We paid no interest at all for this car.

The difference between the “first to second car” and “second to third car” scenarios is nothing more than a little advance planning and thousands of dollars saved.

Plan Ahead for a Car Replacement (46/365)

It is always a relief to be without a car payment. Sarah and I paid off our second vehicles in 2007, and we were thrilled to be without those monthly bills.

At the same time, we recognized that we would be needing car replacements in the next two or three years, so rather than just ending our car payments, we kept making those payments into a savings account – and with a little bit on top of that.

When we replaced our vehicles in 2009 and 2010, we were able to pay cash for each of them. No interest lost.

Now, we just put a relatively small amount each month into our car replacement fund – about $250 a month. By the time we need to replace a vehicle, there will be more than enough cash in that account to just replace it. By the time we need to replace the other one, we will have plenty of cash to replace that one, too.

We like to think of it as our “money saving car payment.” Instead of writing a check to a large bank, where a decent chunk of the check doesn’t even go to pay off the car but instead goes into the bank’s pocket in the name of interest, we put that money into a savings account that builds interest slowly. That money stays in our pocket, actually helping us when we buy our next car. Interest works in our favor this way, not against us.

The next time you pay off a vehicle, don’t stop the car payments. Just start putting that money each month into a savings account somewhere.

Then, when you actually need to replace the car, empty out that savings account for the purchase. You might have enough to buy the replacement car, but even if you don’t, you’ll get a loan with some mighty low payments.

At that point, keep making the bigger payments to your savings account, just like you were doing, and pull your payments for your current car out of that account. When you can pay it off, do so, and don’t stop with the payments.

Eventually, you’ll be able to just write a check for your next car, at which point you can reduce the amount per month you put into that account, often by quite a bit.

For example, let’s say you typically buy a $10,000 car, and you trade in a car that’s worth $1,000 for it each time. You trade in every five years.

The first time you do this, you’ll have a $9,000 loan at 7% for 3 years. Your payments are $289 a month. At the end of those three years, you keep putting that $289 a month into a savings account that earns 1% interest.

At the five year mark, you have $7,000 in that account. You can either go in and just get a loan for $2,000 on your next car, or you can stretch it for another several months and write a check for your new $10,000 car.

Once you have that new car in hand, you just need to save up $9,000 over the next five years, so you can trim your monthly savings down to $150 a month.

$150 every month is far cheaper than $289 a month for three years, then $0 a month for two years in an endless cycle. You’ll save about $1,500 every single car cycle doing things this way.

This post is part of a yearlong series called “365 Ways to Live Cheap (Revisited),” in which I’m revisiting the entries from my book “365 Ways to Live Cheap,” which is available at Amazon and at bookstores everywhere. Images courtesy of Brittany Lynne Photography, the proprietor of which is my “photography intern” for this project.

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  1. Kathryn says:

    This is what we are planning to do, and are doing so. We paid off my husband’s car last year, but have an automatic payment from checking to savings. My car will be paid off in April, and we will do the same, but with one difference: I want an entirely separate account for the “car payment savings.” I do not want to see our savings go up and down for various expenses, so we plan to open separate accounts knowing those accounts are the ones to fluctuate, not our regular savings.

    I bet you take a big hit, tho Trent, in talking about your “new” car for $10,000. It is hard to get a truly new car for that price, and some folks aren’t willing to buy used.

  2. cathleen says:

    We have qualified for a 0% loan so it doesn’t make sense to me to pay cash this time (though I have in the past). I can get a better return by maxing out my 401(k) with 100% match or even a lousy savings account.
    Also, this way I have cash in the bank, which I prefer.

    We will pay off the loan in four years then keep the car a minimum of ten, which is how long we usually keep our cars.

    But that just shows that the old rules don’t always apply, you have to look at each situation.

  3. AnnJo says:

    Why plan on changing cars every five years?

    If you pick a suitable car to start with, maintain it well, drive it carefully and minimize your mileage as best you can, it should be good for 10-15 years or more. And if you do those things, chances are your car is really worth more than you could expect to get for it on trade-in, since no dealer can be expected to know and believe that you have truly taken good care of your car and give you full credit for that.

    I’ve been driving for 35 years and am on my third car. It’s 14 years old and I plan to keep it at least another five years if my mechanic can keep it running that long, and there’s no reason why he shouldn’t.

    I think a lot of people change cars out of boredom or fear of appearing unfashionable or stodgy. That’s a problem that can be minimized by picking a car you really like and are comfortable in, in the first place, keeping it spiffy-clean and smelling good, and if necessary to keep your interest up in it, buying a new toy for it every few years (new seat covers, an upgrade to the sound system, etc.) or replacing/restoring something that looks shabby.

    Most of the depreciation in a car comes in the first three to five years. After 10-12 years, you’ve basically depreciated it as much as it’s going to go, and you’re driving for free (aside from gas and maintenance).

  4. lurker carl says:

    I’ve been driving the same old Chevy Suburban (1988 vintage) now for 14 years, it was already 10 years old when I bought it for a few thousand dollars. I have driven it over 300K miles without any breakdowns or major repairs, just the routine replacement of brakes and tires and hoses and belts and wiper blades and lower ball joints and other typical wear out items. It easily passed this year’s annual emissions test and mechanical inspection and EVERYTHING still operates as it did when new, even the AC is ice cold. The biggest issue I’ve had is the clearcoat finish is flaking off the roof and hood. Next year, it qualifies as an antique and it is still worth about what I originally paid for it. And we still drive it 25K miles each year, everywhere and anywhere, except I don’t use it to tow our camper long distances anymore.

    I didn’t pay interest on this purchase either.

  5. Marie says:

    My father has done exactly what you describe. He also taught me that if you take out a loan for a car, you should plan on keeping it for a minimum of twice the length of the loan. 5 year loan = 10 year car. If you don’t have a loan, you should plan on keeping it until you have the cash to buy another one.

  6. Sandy says:

    I’m glad to see most posters here have some sense! I have never understood the American obsession for constantly getting brand new cars, and constantly paying off car loans ( as my American husband has explained to me ). New cars here cost pretty much upwards of $20,000, so most people can’t afford one anyway. We have a 1992 Nissan Pulsar, and we look after it. I bought it 3 years ago and it cost me $2000 ( which was cheap ).It gets serviced once or twice a year and my mechanic reckons it will go for ages yet. Cars are bottomless pits that you throw money in. You may as well drive any car into the ground. And, if you’re going to upgrade, you are better to get something 6 months old, it is as good as new, but worth way less….

  7. Noel says:

    I am in a position where I can buy a car in cash. The problem is, I am new in this country and do not have enough credit history so I plan to take a loan ONLY to build my credit history, isn’t it weird? I hate to pay the interest as well, esp when I have enough cash but I was told that is one of the way I could build my credit history and it is like gold standard !! I plan to take loan against my cash deposits so hopefully my interest rate will be a little less.

  8. Heather says:

    We had a similar story to Trent’s about our car purchase histories. We had finally paid off both our car loans and for the first time in many years were car loan free. I had started following this blog and when I read that tip, I couldn’t believe how simple. We already had the car payment in the budget! We immediately started putting a “car payment” into savings. When it was time for me to replace my car we added our income tax refund to it and paid cash for our “new to us” car. We did our research and went for a used model with good ratings. We continue to stash the “car payment” for my husband’s car replacement in a couple of more years.

    It is a nice feeling to own our cars outright. Building the car replacement fund provides security that if something catastrophic happens and we have to replace the car sooner than anticipated we have a healthy down payment – though the goal is debt-free replacement. Until we started this process, if anything had happened, we would have been in a position to finance the entire purchase price.

  9. getagrip says:

    Dave Ramsey has a good video presentation of this process. Though the video uses 12% returns on the money being saved, which tends to make me gag a bit, the concept is sound and presented in an entertaining manner.

    My college aged kid asked me why I purchased a used, nine year old vehicle, with plans to keep it five to six years minimum when (in their eyes) I can afford a new vehicle with a loan and keep it 10-15 years. That I’ve likely saved $20K or more and I haven’t seriously impacted my cash flow for the next four to six years while they and their siblings are in college didn’t dawn on them.

    I do, however, take solice in the point that they’re at least thinking long term.

  10. Angie unduplicated says:

    @getagrip-I buy cheapies, plan for one or two repairs the first year, and keep ‘em till the engine or tranny dies or until Detroit quits making OTC parts. I generally get ten years out of the thousand or so initial cost.

  11. DOT says:

    did almost the same as #2.
    We have a car replacement fund and planned to pay cash for our new (yes, brand new.. I buy new cars because that is what I prefer. I know I could save money buying used, but I could also save money by dumpster diving food, living in a trailer or walking to work but I do not prefer those money saving tricks either.) The Honda Pilot cost $34,000. and at the time my credit union was offering a 1% car loan And also a special 7 year CD at 4.5% ( this was almost two year ago.) So we took the 1% car loan and then moved exactly the amount of the car purchase from our car fund account at .75% to the new 7 year cd at 5%. Worked out better than paying cash and we are still funding the original car fund for future purchases.

  12. Tom says:

    One thing to look out for if you look at 0% interest car loans, is that sometimes it will disqualify you for some other credit. For example, your dealer may run a $1500 off or 0% financing offer. If you don’t realize this and don’t haggle, you’re effectively paying $1500 extra in principal for a 0% loan. It could be worth it to put down a large down payment and take the lowest interest loan available if it will reduce the total principal and interest, if you can’t negotiate the credit and the 0% loan.

  13. jim says:

    I also think 5 years is too short. My first car lasted me 10 years easily and my current car is already 5 years and I hope to get 5 more out of it.

  14. DOT says:

    I also agree that 5 years is too short.
    Even though I get blasted by some for buying new we always keep our cars for 12-15 years. When I purchased the pilot, I sold my 1997 Astro Van that had 292,000 miles on it… and it still ran great, even the AC.. paint,carpet, seats, plastic stuff (?) on the doors looked pretty rough after 14 years though.

  15. AnnJo says:

    I don’t know where all the clunkers went after the Cash for Clunkers boondoggle, but if they went to junkyards, there should be plenty of replacement parts out there for older cars, including the means to swap out rough-looking seats, dashboards, etc., for newer-looking ones. I got my second car repainted at about 13 years, and although the finish was not quite as good as new, the car looked quite decent through its 18th birthday, when I finally disposed of it.

  16. Slccom says:

    AnnJo, no, replacement parts are not available. They just got crushed and parts were not pulled. Sigh.

    Did you throw the car a party? After 18 years, that is impressive! Personally, I sometimes cry a bit when selling a car I’ve had a long time.

  17. AnnJo says:

    Slccom, what an enormous waste of resources! And they had the nerve to spin it as environmentally beneficial.

    No party for the car and, much as I loved that car, no tears. It was time to move on, for both of us. Just donated it to a local charity. If I found out it went into the Cash for Clunkers maw, though, I might shed a few tears. It still had plenty of good years in it for someone with better knees than mine.

  18. jim says:

    They were allowed to salvage some parts from the cash for clunkers cars. The engine and transmission had to be scrapped but the other parts could have been salvaged. If there was demand for such parts they probably would have kept them. It was left in the hands of salvage yards who would have maximized the salvage benefit.

  19. Slccom says:

    Sadly, I have been unable to find the parts I need for a 2003 Honda Accord. The salvage yards here didn’t pull much.

    That whole program is so stupid!

  20. jim says:

    Honda Accords wouldn’t have qualified for Cash for Clunkers. They only took low MPG cars.

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