Why you should pay cash for your next car
We have found the best way to purchase a vehicle is to buy a used car and pay cash. This mitigates the risk that you’ll owe more for a car than it’s worth, while also leaving room in your budget to save for the future. Carrying a car note for years acts as an anchor for your saving capability.
Cars.
We love them here in the U.S.
There are few things as central to American culture.
As the saying goes, “Baseball, apple pie, and Chevrolet”.
I confess I am a bit enamored by the look and power of several types of cars. When I was in high school my uncle restored first-generation Chevy Camaros; an emblematic muscle car if there ever was one.
It was fun seeing him resurrect these rust buckets that were yanked from barns around the state and brought back to life.
I even had the pleasure of earning $6/hour to sand rust off some of these projects and, once or twice, I even got to drive one.
Maybe you’re an off-road lover or find interest in the shift to the electric vehicle.
Whatever your bent, a vehicle or two has probably caught your eye over the years.
And even if cars aren’t something you’re really into, chances are you have or need one from a practical standpoint just to live your life day-to-day.
Over 91.5% of American households own at least one car. Some households have more cars than people.
Unless you live in an urban setting with sufficient public transportation, you understand the cultural expectation in America that you’ll procure most of your transportation in the form of an automobile.
Given this cultural gravitation toward car ownership, approaching the purchase of a car strategically can pay extensive dividends to your monetary well-being.
Approach such an important purchase carelessly, however, and you could find yourself carrying a financial ball and chain for years to come. In this post, we’ll ultimately explain why you should pay cash for your next car.
The Basic Purpose of a Car
You’d think “why?” is the first question one would ask themselves before undertaking such a costly endeavor as a car purchase.
Maybe it’s because it seems obvious, but I don’t think many car buyers get to the root of why they want a car before setting out to buy one.
Generally, we assume the answer is we need transportation, then we set out to find it in a manner that accommodates our tastes for style, appearance, or utility.
But let’s get back to the basic question here. Why do we need a car at all?
If the answer is transportation, and we aren’t yet financially independent, then shouldn’t our object be to get it as inexpensively as possible?
Don’t you normally look for the least expensive way to buy clothes, food, and other basic goods?
Unfortunately, instead of evaluating highly practical measures like how much each mile of transportation is going to cost, the marketing prowess of the automotive industry has misled many of us into assuming the evaluation begins by calculating how much we can afford to pay them each month.
It’s as if we’ve just surrendered to the idea that we’re going to need to trade a huge chunk of income each month for the pleasure of owning their product.
Don’t buy their siren song!
Yes, it is a big purchase, but no, you do not have to take out a loan to own a car. You can pay cash for your next car.
We know because we’ve owned 7 cars ourselves and we’ve always saved enough cash to buy them first.
In our experience, next to beginning saving early in our 20s, not having a car note to pay each month has probably been the largest single contributor to our financial success over the years.
We’ll illustrate how later, but I want to really drive home this most basic point. This one transaction of buying a car has wide-reaching financial implications that far exceed the MSRP on the car’s window.
We know the idea of paying cash for your next car may be unpopular, but if you really want to know the quickest path to financial independence then you need to know that it doesn’t include thousands of dollars in car debt.
Let’s dig in and show you why.
How much can you afford?
For kicks and giggles, I googled the question “how much car can I afford” to see what results popped up.
The first page of suggestions had 12 links. Two were advertisements; one was from a popular online car dealer and the other was from an automobile insurance company.
The other ten links were from a variety of financial, insurance, and banking websites.
Do you know what they all had in common?
Every single link went to a site that offered to help readers calculate the available space in their budget for a monthly car payment.
In addition to these helpful categories, several sites suggested overall purchase budgets of anywhere from 15%-50% of one’s annual income or 10%-25% of your monthly income on a car payment.
I wonder if these are the same people suggesting that you spend 40% of your monthly income on a mortgage too?
Now, to illustrate how careless many of these suggestions are, let’s pull in our old friend, Average J.
Average J Buys a Car
For those of you who haven’t been introduced, Average J’s full name is Average Jane or Joe (you get to pick which) and Average J represents the most average American possible.
Everything in Average J’s life is the same as the American average for any given category.
Thus, Average J has an average budget, average savings rate, average height and weight, average home, average car, average income (well, median. see below.), and so on.
Naturally, when Average J buys a car, he or she will be spending an average amount, getting an average loan, and have an average monthly car payment to make each month from his or her average income.
In 2022, Average J spent $42,736 on a new car and has a monthly payment of $667 before insurance. For this example, we will assume Average J is single since using household averages with only one car doesn’t align with the average household.
Most households have two or more cars or at least one for each driver in the home.
Average J’s income is $54,131, the median as of June 2022, which means after average payroll deductions, Average J takes home a very average of $3,530.15 each month. (We don’t use the average for income because wealthy guys like Elon Musk skew the numbers too far to the north.)
This means Average J’s monthly car payment of $667 is 18.89% of take-home pay.
On the surface, this may seem very affordable. After all, 81.11% of Average J’s income is left for other expenses.
About those other expenses; I took the liberty of pulling some data about how Average J also spends his or her hard-earned money on basics like food, shelter, and utilities. See the results below.
Average Monthly Expense | Average Monthly Cost | As a % of take home pay |
Avg Cost of Housing | $1,050.00 | 38.70% |
Avg Monthly Car Payment | $667.00 | 18.89% |
Avg Groceries | $412.00 | 11.67% |
Avg Clothing | $161.00 | 4.56% |
Avg Gasoline | $131.00 | 3.71% |
Avg Electricity | $114.44 | 3.24% |
Avg Cell Phone Service | $114.00 | 3.23% |
Avg Auto Insurance | $80.00 | 2.27% |
Avg Water | $70.93 | 2.01% |
Avg Natural Gas | $63.34 | 1.79% |
Avg Cable/TV | $59.99 | 1.70% |
Total Spent (So far) | $2,923.70 | 91.78% |
Good news! Average J has managed to spend less than he or she makes. And if this were all of Average J’s expenses, Average J would probably be okay.
However, we haven’t included regular costs like eating out, getting a haircut, entertainment, and vacations, and it seems like there’s something else missing…
Oh yeah, saving for the future.
The truth is the Average American is spending nearly 60% of their take-home pay just on housing and a car.
I’ll grant that these items are necessities, but the expense they create is effectively forcing the average person to work perpetually until they die.
Without a steady income to cashflow this maxed-out budget, Average J would go bankrupt. Retirement and financial independence are not an option for Average J because Average J already spent all his or her money on other things.
Don’t be average. Be different. Be better. Pay cash for your next car and invest your money instead.
Why Average J should pay cash
If Average J decided to buy a car with cash it would hypothetically free up $667.00 a month to save and invest, right?
Well, sort of.
Don’t forget that since Average J is paying cash, he or she will need to set back a little extra for the next car purchase in 5 years.
Let’s assume Average J finds an old beater and plans to drive it for 5 years before upgrading with a budget of $20,000.
This means Average J will need to set off half of that monthly payment ($333.33) for the next car which will be bought in 5 years (60 months x $333.33 = $20k).
Now, Average J has $333.67 to plug into retirement savings. The value of $333.67 saved monthly for 5 years with our typical assumed annual return of 10.67% (the average return of the S&P 500 since its inception) after 10, 20, and 30 years?
5 years – $26,534.95
10 years – $45,132.61
20 years – $130,567.36
30 years – $377,727.66
The amount accumulated if this money is spent on a depreciating car instead?
$0.00.
Bear in mind, these are the numbers if Average J stops contributing after year 5. If Average J recycles this strategy and continues buying cars with cash throughout his or her life, the dollars only go higher.
This is the power of compounding interest and the primary reason you should pay cash for your next car.
I also want to point out that we have the deck stacked heavily in the favor of the borrowing crowd here. There are actually a few ways:
- The expense list we highlighted was missing a lot of basic stuff and didn’t even leave any room for emergencies. In all likelihood, Average J is spending more than he or she makes.
- This plan allows Average J to buy a car every 5 years. Most people can probably stretch their automobile further than that unless they’re driving over 40,000 miles annually. As we’ll discuss later, the longer you own a car, the less expensive it tends to get.
- We also haven’t pointed out that buying a new car could leave you exposed to owing more for your car than it’s worth. In many cases, the rapid depreciation of vehicles leaves borrowers in a bind if they get in a wreck or need to sell quickly.
- Finally, the amount you end up paying for the car far exceeds its value because a loan pits interest against you instead of in your favor:
If Average J’s $42,736 car purchase with a $667 monthly payment was made with a 5% interest loan, then we can deduce that Average J paid 17% ($7,265.12) of the car’s value as a down payment upon purchase.
It also means that Average J will pay $4,692 in interest over the course of the next 5 years.
By paying cash and putting just $333.67 into savings each month, Average J could have made $6,514.75 in interest over the same period.
That’s an overall net worth difference of $11,206.75 ($4,692.00 + $6,514.75) between borrowing and paying cash in just five years.
What all of this basically shows is that there’s more cost to borrowing for a car than just a monthly payment. A car loan forces you to sacrifice so much in opportunity costs for what could have been saved and invested over the same period.
You’ve really got to love that new car scent to give up so much for it.
In all likelihood, the average budget is leaving most people with the feeling that they’re trying to bail water from a sinking boat with a teaspoon.
They probably feel like giving up and certainly don’t have much hope for success.
That’s why even though our direction to pay cash for your next car may seem challenging to many, it’s so important.
We know because it’s exactly what we’ve done ourselves.
What Car Should I Buy Then?
Ideally, you want to buy a car after its price has depreciated significantly quicker than its useful lifespan, but just before that trend slows down.
That’s the point when your miles/dollar ratio is probably going to begin offering the greatest value.
I’ve inserted a quickly assembled graph below to illustrate:
You’ll notice that Average J’s $42,736 car has depreciated rapidly in years 1 & 2. After year 2, however, that curve begins to flatten out and descend less quickly because the rate of depreciation is slowing.
Typically, this is when the car is going to have the most to offer in terms of useful life but has already taken the steep depreciation hit in the first two years of its life.
Historically, we have bought cars that were 2-4 years old with 20,000-35,000 miles on them. For us, this is the right time to buy, but in terms of pure value, it actually serves you best to wait as long as possible for depreciation to take its toll.
Truthfully, older cars with lower miles have the most to offer in terms of miles/dollar.
If you don’t mind driving something a little older and want to maximize your money spent on a car, buy something old but in decent functional shape.
Cars tend to get cheaper the longer you drive them
We would also encourage you to drive your cars as long as possible.
Currently, we’re averaging a car replacement every 12 years, but are looking to extend that average if possible.
The reason is your car will tend to get cheaper to own the longer you drive it.
Going back to the viewpoint we discussed at the beginning (the primary function of a car is transport), we suggest measuring the value of a car by how many miles it provides per dollar spent in the vehicle’s operation.
For example, if you own a vehicle for which you spend $6,000/year on taxes, insurance, maintenance, and fuel, while also accumulating 15,000 driven miles, your miles/dollar ratio is 2.5.
Average J spends $10,728/year operating his or her $42,736 new car and drives it 14,263 miles annually. Thus, Average J’s miles/dollar ratio is 1.33.
Evaluating a purchase in this format highlights the impact of gas mileage, insurance, maintenance, taxes, and other ownership costs.
The longer you can keep your vehicle running well, the better this ratio will get.
However, there will come a day when your car may be more trouble than it’s worth. Eventually, every car will face a catastrophic failure that will end its useful life.
You don’t want to start throwing good money after bad, so be sure you’re evaluating those maintenance costs thoughtfully as your car gets older.
When is it okay to splurge?
So, you’re saying I have to always buy used?
Nope.
To be clear, we’re advocating for you to pay cash for your next car, even new cars if you can afford it.
New or used is up to you, though we do think it makes sense to buy used when trying to save for your future.
Over the years, we’ve upgraded our car purchases as we’ve had an easier time meeting the milestones on the Next Dollar Roadmap. By driving unremarkable cars early in life, we created a basis from which to own nicer vehicles now.
I also want to point out that you may need some flexibility around safety and utility here. Our primary focus when we bought Lisa’s last car was safety, followed closely by reliability.
We wanted assurance that she and the kids were in the safest car possible while also not having to take it to the shop every other month for a costly repair.
Even most used cars in the United States are built with sufficient safety features but don’t ever trade reasonable safety for the sake of saving some money. That trade-off is not worth it.
If you’ve got your eye on a really pricey set of wheels, I’d wait until you’re at least past milestone 5 (investing 15%-25% of your income for retirement) to pull the trigger.
Somehow, I don’t think that fancy car will look as nice in your kid’s driveway while you’re living in their basement.
Conclusion:
That was a lot of info, but I hope you understand why we took the time to put this together.
Overbuying and overborrowing for cars are two of the most detrimental choices Americans make at the expense of their own financial independence.
Buy used. Pay cash. Build wealth.
