Updated on 08.14.07

A Down Payment Dilemma: Buy A Car Or Keep Saving For A House?

Trent Hamm

Jerry wrote in recently with the following problem:

I and my wife are both graduate students; we recently paid off all our debts and started on a savings plan for the next few years that I am hoping will be our big downpayment on our first home. With our current salaries, we have been saving about $800 a month, with $5000 in the kitty already. However, a new situation has come up: Our current car is really old and we want to invest in a new car – (a fuel efficient subcompact). The logical thing for us to do would be to put down a sizable payment, trade in our old car, and have low monthly payments. At this stage in our lives (still being grad students) low payments are what we can afford. But I am reluctant to give up our hard saved money, especially since we have come to see it as a downpayment for our home. I dont know if I am thinking right about this, so it would be really helpful if you could give your opinion on the financially sound thing to do.

There are a lot of issues to look at here. I am assuming from the description that your current automobile is significantly less fuel-efficient than your current car and that you use it for commuting – this is based on your focus on fuel efficiency for the next automobile purchase.

The first thing I would do is calculate exactly how much you will save on fuel by switching to the new car in a given month. Let’s say your current car gets 15 miles per gallon, your new one gets 30 miles per gallon, and you drive 900 miles a month. That means your old car uses 60 gallons of gas per month and your new one uses 30. Assuming gas is $3 per gallon, switching to the new car is an immediate savings of $90 per month.

Then, I’d use that fuel savings calculation (be sure that it is conservative in terms of your actual usage so you don’t overestimate) and draw up a pre-car monthly budget and a post-car monthly budget, assuming you use all of the saved cash as a down payment on the car. My sincere advice to you is to keep saving until the down payment reduces the cost of the car low enough that there is, at the very least, no change in your monthly budget when adding in the cost of the car and subtracting the fuel savings.

Remember, the larger your car payments, the more they will slow down your progress. Not only will you not be able to save as much each month, but you’ll also be spending more each month on interest, not on the car itself. You’re always better off waiting and saving for a new car.

The best solution? You may not like it for now, but in the long run, you’ll probably be in the best financial shape if you save up for the entire cost of the car now, pay for the car in cash (and with the trade in), then start saving in earnest for the house. You’ll be in the best possible situation for the house if you do it this way, because making car payments will just slow you down.

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  1. I tend to agree with Trend. In fact, if your old car still runs without major problems, you should keep it for a while. Ok, you might save $90 a month in fuel (if you can save this much!) but your car payment will be much higher. Please also note that your car insurance premium will rise as well as the value of the insured property will increase accordingly.

    The best thing to do is to keep up with your old car until you buy your house. Then, wait another couple of months as new expenses may arise. I am a home owner for two years now and there is a lot of things I discovered I needed to live in my house.


  2. Sick of Debt says:

    This may not be for everyone, but at the beginning of May I bought a used fuel-efficient compact for $400. It had some exterior damage to the vehicle and high mileage, but nothing really wrong that a tune-up and radiator flush couldn’t fix (did myself). It’s been going for 3 & 1/2 months and I’ve put on 8K miles (some of those reimbursed by work). Even if it died tomorrow, I feel it has paid for itself with fuel efficiency and no concerns about using it for work.

    The logical thing for this couple as graduate students is not to be taking on monthly payments, as you stated. The marketing folks want them to believe that having monthly payments is logical.

  3. Javi0084 says:

    There are plenty of efficient 4 cylinder cars for under $5k.

  4. Dboy says:

    If it runs, keep the old car. If fuel is really a problem, find an old Mercedes Benz 190D. Got mine for under $1000. Very high quality car for the money. It will run forever and gets over 50MPG.


  5. Zot says:

    I would buy a quality used car. Given the housing market I wouldn’t buy a house for at least 2 more years. But as you say, I think I would first calculate exactly how much I would save in gas, and maybe even try and estimate how much house I wanted to buy and when, so that I could see whether I would realistically have enough for a downpayment by the time the house buying option becomes reality.

  6. Hope I’m not double posting. I don’t see it yet.

    I would buy a quality used car. Given the housing market I wouldn’t buy a house for at least 2 more years. But as you say, I think I would first calculate exactly how much I would save in gas, and maybe even try and estimate how much house I wanted to buy and when, so that I could see whether I would realistically have enough for a downpayment by the time the house buying option becomes reality.

  7. benp says:

    the larger your car payments, the more they will slow down your progress”

    I think this is the wrong way to look at it. Total cost of the car is much more important than “payments”. Also I would really quibble with the questioners frame of mind. They are not “investing” in another vehicle and if they can save 800$ a month then they could afford a fairly large car payment. For example, they could buy and pay for a 10K used car in little over 5 months. A car in that price range could last for a long time and the idea of paying it off quickly will make them much more price sensitive. Running their current car until it breaks might also start to seem more appealing.

    Also this seems like a false dilemma, yes they need to be saving for a home, but as grad students, they need to graduate and gain a little stability in job before they purchase home. Keeping liquid money now (using longer term credit for the car, say 2-3 years) doesn’t really help. Its sounds a little like they just want a new car, but are sad to see the house fund go. Hopefully this post will help them think about the tradeoffs.

  8. PJ329 says:

    If possible keeping the current car is probably best. The fuel savings is not likely to offset the cost of a new car. In the event the current car must be replaced, I suggest looking into purchasing a quality used model. Consumer Reports has a list of reliable used models you may consider. So that you do not pay too much or accept too little for your trade, check the car values on kbb.com and Edmunds.com. Also, crashtest.com is good for safety ratings.
    With the housing market in a slump, there could be some good deals for home buyers either now or in the near future. Don’t pass up the opportunity to buy a home. A house could last a lifetime and almost always goes up in value. A car lasts maybe 10 years or so and only goes down in value. Therefore I suggest trying to keep the house purchase a priority.

  9. Toby says:

    “You’re always better off waiting and saving for a new car.”

    Say what? Please be careful with absolutes like always and never. They are seldom accurate.

    If you have enough to pay cash for a car but you can get an extremely competitive interest rate (3% or less) then I would argue that it is rather foolish to hand over that money. Sure, in a vacuum, if you consider financing versus paying cash, you always make out better paying cash. But if you consider the Opportunity Cost of spending that money on a car instead of investing it over 4 years, you’ll probably think twice.

    Even billionaires finance their cars, yachts, and jets because having their money continue to work for them is more lucrative then paying a lump sum for a depreciating asset.

    Opportunity Cost – key concept for business, key concept for life.

  10. Mark McGuire says:

    The key word here is grad students. Your car is no less “fuel efficient” than it was 10 years ago. My brother who was a grad student at MIT and his wife a grad student at Harvard kept the same 1989 VW Fox for 12 years before junking it.

    If you are a grad student using it for commuting, most likely you are not using it for long road trips. Keep the junker as long as you can till you get a job or work on your post doc.

    If you have to buy a car, go with a used car, we are still a good 10 years away from a real “fuel efficient” society. Grad students always walk or take the subway.

  11. Jerry says:

    Thanks to Trent for answering my question and to all the others for their responses. Indeed there are a lot of things to be considered. To be fair, there are other variables that are influencing our decision too – and I just presented a simplified scenario. Its not that we just want to get a new car – our car is really close to being broken. I think we will give another consideration to getting a used car.
    I look forward to more comments from other readers.

  12. Larry says:

    There are some really good points made above, but I have a few questions. How far are they from graduation? Won’t their income greatly increase upon graduation? (although they are going pretty well for grad students if they can save $800 a month). My stipend in grad school barely paid rent and utilities. That being said, Jerry said they just got out of debt, so I’m suprised they are wanting to rush back in. With interest and higher insurance premiums, they’ll probably only break even by saving on gas.

    Finally, Toby, I love see where you got your information on billionaires. The most comprehensive study I’ve seen on millionaires is the book “Millionaire Next Door” by Tom Stanley. In his study, he found that the average millionaire bought a 2 year old car for cash.

  13. vh says:

    Figure out what the clunk is costing you to drive & maintain. Then figure out what a new car AND the interest on the payments AND the exorbitant costs of registering and insuring a newer car will cost. A little English-major math revealed that if I traded my seven-year-old gas-guzzling Sienna (a.k.a The Dog Chariot) in on a new fuel-efficient car, it would take until 2028 for the new vehicle to pay for itself…assuming the thing was still running by then.

    You can make the same cost estimate on a used car. Remember to add in the transaction costs involved in the purchase as well as taxes, pollution tests, registration, & whatnot.

    These exercises might breed a deeper appreciation of the Clunker.

  14. Liz says:

    Keep this in mind regarding “efficiency,” a lesson from green building : ) It is usually more efficient to keep a house that is not energy efficient rather than tearing it down and building another one that will be energy efficient. It can take a long time to equal the energy savings.

    However you may want to go ahead and invest if you are paying significant amounts for car repairs, or if you feel unsafe driving. Look for a used car if saving money is your object. I think the conventional wisdom is 2-3 years old gives you a big savings off the sticker price without having to worry about repairs.

    Good luck!

  15. Jeni says:

    I’m having a similar dilemma right now as well. I have a ten year old car that was doing great, but I just spent $500 fixing something minor on it yesterday, and I will probably have to spend another $1000 on it in the next year to keep it running well. I don’t know how you know “when” it’s time to get rid of the old car (which keeps costing more and more to maintain, while losing value) and get a newer used car.

  16. DrBdan says:

    From a different angle, I would like to add that, depending on how much these folks need to drive, car sharing can be an excellent option. In my experience if you can take transit to work and then use car sharing for the other times you need a car you can save a lot of money. It doesn’t work if you need to drive a car to work everyday though.

  17. maxconfus says:

    If you will be buying a house, depends on the situation of course, but you may want to consider more than a sub-compact; unless of course you have regular access to a pickup. With a house comes many responsibilities like home maintenance which entails many trips to your local home supply store. Many of the items you will need over time will not fit in a sub-compact which will leave you in a position to rent or pay for delivery which adds to the cost and may justify a larger vehicle.

    /my two bits
    /homeowner 10 years
    /family of six

  18. sandy says:

    Please consider the depreciation “cost” of buying a new car as well. The instant you drive whatever it is off the lot, you lose a large chunk of change that you will never get back.
    There is a fellow peddling a book about the hidden costs of buying new cars (I don’t remember his name, but have held the same philosophy since I lost $20000.00 Cdn owning a new car) – his tenet is buy a 3 year old car (lease return) and drive it until it is 10 years old (the average age that cars start to require major work).
    Cars are generally NOT an investment – they are a necessary evil, and the key is to minimize the amount of money you lose over it’s lifetime.

  19. Kim Isaac says:

    If at all possible look into a reliable used car and pay cash for it. I wish I had done that on my first car.

  20. Nozferatu says:

    I’m faced with a bit of a dilemma.

    Back in 2005, I sold my VW GTI so as to not have any payments. I purchased a used 2001 Ford Focus and paid for it in full. The car is running well but will probably need about $1K of work to keep it maintained and safe (i.e. new shocks, tires, probably a timing belt, etc).

    One thing that happened to the car that makes me nervous is when I purchased it, I changed the plugs immediately. Well, the old plugs were so badly worn that a piece of the ceramic end of the plug chipped off and fell into the engine block. Needless to say, I didn’t realize it until the engine fired up again. The noise wasn’t pretty but the piece went out the exhaust port and things cleared up. Now the engine has a bit of a clattering sound when cold. It worries me because I think there was some damage done although I experience no oil burning or power loss or poor fuel mileage.

    Anyway, my point is that the car needs some maintenance work. Now…the kicker. My sister needs a car but can’t afford one. So I was thinking I’d give her this car and she can pay me monthly for it interest free…at a lower price than what I’d sell for outside.

    The dilemma…I need to get another car. Frankly, I don’t want to get another used car. I;d rather get a new one and keep it for a while. I already made the mistake of selling my GTI (economically speaking) but I don’t regret it. Being payment free is wonderful but obviously my Focus doesn’t have the safety and comfort of a newer car.

    What do you guys think? I’ve had the Focus now for about 2.3 years. It has about 60K on it. I bought it for around $6.5K and will give my sister a price of $4K and she can pay me whenever, however monthly.

    I’ve been looking at the 2007 Nissan Sentra SER model with CVT transmission…slight better fuel mileage than the Focus even though it’s more powerful and larger. I can get one for $16,995K +T/L…a very good deal considering the INVOICE is like $19K. I guess they want to move these things for the 2008’s.

    Insurance I checked is like $60 more per year than the Focus believe it or not.

    Any opinions? Suggestions?

  21. Jack says:

    I would absolutely keep the old car as long as bumanely possibl. If repairs average out to $2000 per year or less, keep the car. This does not include general maintenance, such as tires and oil changes. I’m talking only about repairs. Even if it needs a rebuilt transmission or engine, it will be far cheaper to keep your old car running, unless your old car is really a lemon, where everything breaks all the time. If you buy a newer car, and you’re low on money each month trying to pay bills, it’s not worth the aggravation. But it sounds like you’re looking for an excuse to buy another car. Sit tight!

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