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.
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.