How to Buy Your Next Car in Cash

Rolls-Royce-Blue-Phantom

The other day while a friend and I were chatting, the subject of buying cars came up. When I mentioned that I pay for my cars in cash, he expressed some awe: the very idea of not having to make car payments was so far outside his ken it might as well have come from Mars.

“Who can pay for a car in cash?” he wondered.

You can. I can. Anyone can.

You may not be able to pay for your present car in cash, but you can pay cash for the next one. Here’s the strategy:

Take the term of your present loan and multiply the number of years by two. Let’s say you have a five-year loan. Five times two is ten years. That’s how long you’re going to keep the car you’re paying on. Fortunately, most cars are now built to last that long, if you take halfway decent care of them—so, plan to change the oil and stick to the manufacturer’s maintenance schedule.

OK. So you make your monthly car loan payments faithfully, as you agreed to do when you bought the chariot. In five years, the car is paid off.

Let’s say you’ve been paying $450 a month toward the loan.

You know… If you can afford to pay $450 a month to a lender, you can afford to pay yourself $450 a month. Right?

So for the next five years, the remainder of the time you’ve scheduled to drive your now paid-for clunk, what you’re going to do is arrange an automatic transfer of $450 a month into savings.

In five years, when your car is ten years old, you’ll have $27,000 sitting in your automobile purchase savings account. Your car will have some resale or trade-in value—my ten-year-old Sienna, for example, is worth about $5,000. Let’s say yours is comparable: you now have 32 grand with which to buy a new vehicle.

When you do buy the new car, even though you’re paying in cash, figure out what monthly payments would cost if you financed the thing. Take that amount—the new theoretical payment—and put that amount aside over the length of the theoretical loan. In three years or five years, once again you’ll have all you need to buy a new car. Now you can purchase new or new-to-you cars more often. If you decide to drive a car for its entire ten- to fifteen-year lifetime, you’ll have a period in which you need not deduct anything for the future vehicle from your pay.

And you’ll never be saddled with a car loan again.

What if you’re already a couple of years into a five-year loan? What does the math look like then?

It should be about the same: you’re going to keep the car for ten years. After the loan is paid off, you’ll just keep on making those payments, only to yourself instead of to some lender.

What if you pay off the loan early? Bully for you: you can either buy another car sooner, or you can keep the car until it falls apart like the Minister’s One-Hoss Shay. The second strategy will give you a longer period either to save up more money for a fancier ride or to float without having to take the car payment money out of your income.

My first post-divorce car was bought on time. Being averse to loan payments, I paid off the loan as fast as I could. Because a substantial part of a car payment can be interest (less so these days, but when the economy was strong lenders soaked a fair amount of interest out of car buyers), paying toward principal accelerates the pay-off date. By paying a little extra toward principal each month and then taking every windfall (tax refunds, credit card rebates, yard sale proceeds, whatever comes your way) and throwing it into the principal, too, I paid off a five-year note in 18 months.

Then I started paying myself. I didn’t keep the money in my bank accounts, because it would be too easily accessible there—too tempting. Instead, I banked it in a Vanguard short-term corporate bond fund, which I was less likely to raid for indulgences or emergencies. This rather stodgy fund was safe enough, and it earned more than a bank savings account would have paid. Today, I’d put it in a money market fund instead, because a withdrawal from the money market is not a taxable event. If you know you’re going to withdraw $25,000 or $30,000 in one swell foop, it’s best to minimize taxes when that happens.

This plan really takes no more self-discipline than you have to muster to make your loan payments. It takes some time, but once you’ve got the loop going, you’ll never have to pony up a chunk of your paycheck to a car lender again.

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Nicole May 28, 2010 at 9:26 am

It would never have occurred to me not to pay cash for a car. And getting rid of a car that still works just fine for a new one is an odd thought too.

Like my sister said when she was calling people to repo their cars on Christmas Eve (as a teenager she worked for an atty’s office), never get a loan on a depreciating asset.

Robikate May 28, 2010 at 1:51 pm

I did something similar to this. After I paid off my van in 4 years, I continued to have the payment taken out of my paycheck and placed in my credit union account. I was then able to pay cash for our kitchen remodel; new cabinets, countertops and appliances.

E500 May 30, 2010 at 7:42 am

That’s a nice Phantom

Adam@RabbitFunds May 30, 2010 at 9:21 pm

Great post. My wife and I have paid off our car (we only have the one). Though we are going to need a second car sometime or another, so this is a great reminder to start saving that money now.

Marcus June 3, 2010 at 7:24 am

Bought my first beater in cash at 17 with money I saved from part-time jobs the previous three years. Sold that to my brother and then bought my second car at 20 with half of my 7,000 enlistment bonus. Best decisions ever. Not having that $200-600 car payment eating away at my salary I’ve saved (at now 25 years old) more than the average retired person.

NOT being frugal to me just seems painful, a little restraint from buying that Range Rover in the short term pays off in the long haul.

Forest June 11, 2010 at 4:05 pm

I have never owned a car but certainly is not something I would every consider getting a loan for…. I like the plan though, exactly how it should work :)

The Saved Quarter June 22, 2010 at 4:26 pm

Excellent plan! We bought our last car in 2000 at a police auction for about 2/3 the blue book value. A reliable vehicle, I drove it until it completely died at the end of 2009 with 280k miles. Not having saved for a car in the interim, we’re now paying on time for our new-to-us car – $200 a month. We really could have saved $200 a month for the 9 1/2 years we drove the old car and could have bought a brand new car in cash when the old one died. OUCH! Lesson learned!

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