Updated on 09.12.14

Transition From Car Loans To Paying Cash For a Car

Trent Hamm

Continuing the conversation with my readers on the auto insurance issue, in which I recommend switching to liability insurance once your car’s value gets low, Kellie makes a point that’s worth covering:

I couldn’t get a car loan for my vehicle unless I had full comprehensive on it. So, I can’t switch to just liability until I pay for the entire thing. I wish it were always so cut and dry but it isn’t.

This is yet another example of why paying cash up front for your car is a tremendous deal. I’ve already covered in detail why paying cash is a better deal than getting a loan and a far better deal than getting a lease, conclusions that Money Magazine agrees with me on, but the truth of the matter is that it’s not easy to put yourself in a position to pay cash for a car, especially if you’re just getting started.

So, here’s a plan for how you can actually put yourself in a position to pay cash for a future automobile purchase without changing your current budget. Sound good? Here’s what you do:

1. Buy a late model used car on a loan. I’m somewhat assuming that you’ve already done this. If you’re on a lease, don’t get into another one when you’re finished. Switch to a late model used and start making the payments on it.

2. Make your payments on that car automatically. Set up your accounts so that this bill is paid automatically. This is very important; you need to get into a routine of just knowing that that amount is going away each month and that it’s not part of your routine budget.

3. When the car is paid off, start an automatic savings plan with a high-yield savings account that deducts the exact same amount as the car payment you’re already used to paying. No change to your monthly budget or spending at all.

4. Put liability insurance on your current car and put the insurance difference automatically into the new account, too. Again, no different than before in terms of your monthly budget.

5. Drive the car until something puts it out of commission – or until it’s starting to really worry you or make you uncomfortable. A few minor repairs are probably worth it, but when you hit upon something big – or it’s showing clear signs of approaching a major repair – now’s the time to move onto the next step.

6. Clean out the account, trade in your old car, and buy another one! Don’t forget to maximize your deal on any car purchase. You should have enough cash and trade value to pay for a very large portion of the car, if not all of it. If you have to borrow to make the deal, get the shortest term loan possible and go back to step two.

7. Don’t stop the savings plan! You might want to switch back to comprehensive insurance on your new car at this point, which is fine, but keep putting the rest away into your savings account. The next time around, you’ll be able to perhaps get something even nicer – I have a friend who was able to buy a BMW using basically this exact plan (albeit with pretty high amounts each month).

Writing a check for a car is a great feeling – you have a fresh automobile without any of the debt burden. It is exhilirating to walk off the lot with a car that’s good for several years of driving and no additional debt.

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  1. Jesse says:

    I am a big fan of paying cash for cars and have been doing it for years. Im at the point now where I could pay cash for a new Porsche if I wanted (maybe not turbo). So I have switched my formula to: buy a car at 5 years old, sell at 10. Right now I have a ’99 Grand Cherokee and a ’96 Jetta(which is due to be replaced). I guess my point is, once money is no longer an issue, if you decide you can live with an older car, there is still al ot of money to be saved. Around here salt, rock chips, road construction, and door dings, make me not want to have a lot of money tied up in cars. If I were to spend a lot on a car, I would not do it on my daily driver. I’d buy something less practical and use it more as a weekend toy.

  2. TiP says:

    I have to agree with Jesse, why have a lot of money tied up in a car when your money could be working for you elsewhere? I’d prefer to keep driving my 20 year old car (bought new back in ’87!) and save up for other things like a 20% down on another house (after house prices fall for the next year or so).

    On the otherhand, I do prefer to buy new. It’s just that I haven’t bought new for 20 years, so my car is costing me about $650/year based on the purchase price (not counting maintenance, of course, but so far the most expensive repair was to replace the fuel injectors last year – $600 ). The key to doing this is to choose a car that you think will be durable enough to last a good long time. In my case I chose a Honda. Then treat it well, hang onto it for as long as you can and save up for the next one. At this point I actually think I can get about 3 more years out of my current car. In the meantime I’m waiting for a simple car that gets in the 60MPG range to be released in the US.

  3. Trent Hamm Trent says:

    Jessie, TiP: I agree wholeheartedly. I have only owned two cars in my life, the first one I drove into actual oblivion (a 1985 Buick SkyHawk), and the second I’ve been driving ever since. I anticipate just writing a check for a future vehicle, but not until I drive this one into oblivion, too.

    Paying cash is the way to go, though, when you finally do buy (though that decision is based on other values), and late model useds are the best deal out there.

  4. Tkriger says:

    I wish I had done this, I paid cash for my first car right out of HS, about 5,000 for a decent car, drove it for 3 years, then bought a new car completley financed…I wish I didn’t the $300 a month isnt killing me, but I am looking forward to getting it paid off ahead of schedule and keeping up those payments into ING or HSBC.

  5. James says:

    Although seemingly obvious, most discussions on (more) used vs. new(er) cars don’t make the following point: The older the cars you buy, the more often you will have to buy them. Jesse buys used ones about every five years, and TiP tries to buy new ones only every 20. Thus the long run costs even out a bit when you look at purchases over a lifetime. Given the conditions in some parts of the country, I can understand Jesse’s strategy. However, I agree with the late model used car method from a purely financial perspective–very late if possible. My friend recently got a one year old Camry with less than 12k miles on it. For $7k less than a new one, he got a practically new car that might last 19 years!

  6. Alfa says:

    Great great tips. Thanks!

    I’ll wait for the home version of this post. :-)

  7. Julie says:

    I can’t wait to get out of the car load cycle. I am in the process of snoballing my car payment to get it paid off a year early (I hope). Once it is paid off – I am putting a good chunk of my snowball payment in a savings acct for the next car.

  8. kellie says:

    Thanks for blogging about my comment Trent. I am in the process of trying to sell my vehicle (2002 trailblazer) and buy something – thinking a Toyota Corolla or Prius (if I can find a good deal). I’ve owned, free and clear, 2 vehicles in the past, they were older models (late 80’s early 90’s) and I got incredibly frustrated with the constant problems with them and their unreliability. When you get on first name basis with the guy who comes to start your vehicle – it’s too much. So, I decided to get a loan for a 2000 Chevy prizm however a family member backed into it causing major damage ($3K) to the front a year after I got it. We didn’t report it to the insurance company (I know I know) then the air conditioner stopped working, etc etc. So we decided to trade it in and get this suv. It’s been like 2 years and now we hate this thing. It’s sucking down gas like crazy and needs new front brakes, we already replaced the back, and we had to put in a new alternator. I don’t know what I’m suppose to do.

  9. Richard says:

    I recently bought a new car and found it really helpful to look up the place that you are going to buy the car from on the Better Business Bureau (www.bbb.org). The first place we looked at had about 65 complaints in the last three years. The second place we looked at had 0 complaints. We went with the one that had 0 complaints and were very pleased.

  10. Danielle says:

    I’ve only ever owned cars we paid cash for. We have a 95 Jetta and a 98 Honda Odyssey now. No plans to replace either of them, both are running fine. My husband is great at maintenance and our insurance is cheap. We currently have about 6k on hand saved for replacement cars and are adding to it monthly. No, our cars aren’t fancy looking but we don’t care!

    Oh, and we loved MSNautos.com for reliability rating on used cars! Kept us from making some very bad decisions!

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