If you want to get serious about taking control of your financial life so you can build wealth, it’s time to eliminate car payments.
Car payments are a persistent nag on the lives of many U.S. consumers. But they don’t have to be, and shouldn’t be even with super-low interest rates. Because they crush your monthly cash flow.
According to Experian, the average loan amount for new cars in the U.S. as of Q1 2016 was $30,032. The average car payment was $503 over 68 months. The percentage of new cars that are purchased with financing is 86.3%.
Financing a car purchase is normal.
Last year, I succumbed to the temptation of a low-rate car loan after 11 years of no car payments. And regretted it.
The payment disturbed my financial mental well-being for more than a year and crippled my cash flow. So I decided a few months ago that I had enough.
It was time to change shit up.
Last week I paid the loan off in one $12,852.20 chunk payment. The loan is gone. The title is mine.
Now I’m swearing off car payments for the rest of my life.
Why I Financed Our Minivan In the First Place
I eliminated car payments from my life in 2004. Two-and-a-half years earlier, I bought a new Toyota Echo for around $13,000 with no money down and a $221 payment (4.59% interest rate).
I hated that payment. So I aggressively paid off the 66-month loan in 30 months.
That car gave me nine years of reliable service. Seven of those years were payment-free.
After marrying and while preparing for the arrival of our son, Mrs. RBD and I bought a new base model Honda CR-V. We paid cash.
I remember her saying, “Wow, I really like not having a car payment!”.
Yeah, it’s pretty awesome.
When we had our third child, we decided we didn’t want to squeeze three car seatsin the back of the CR-V. And we knew we needed a long-term solution for our family size. So we sold my wife’s “brand new” 11-year-old Honda Civic and bought the ultimate suburban grocery-getter… the Honda Odyssey.
With a price tag approaching $30,000 (for a low-end model), I wasn’t crazy about putting all that cash into the car when I could get cheap financing. For qualified buyers, Honda offered a 0.9% rate for three-year loans. That was too tempting to pass up. So instead of parting with nearly $30,000 in cash, I put down $9,000+ and financed $20,000. Our monthly payment for 36 months was $563.
The $20,000 I “saved” by financing the car went into the stock market between July and October 2015. This was an excellent time to put money to work in dividend paying stocks. Mathematically, the move was the correct one. The stocks I bought are mostly up and I’m wealthier because of it.
The major downside was that $563 payment.
After just a few months of the regular payment, I started regretting my decision to finance the car. Interest on the loan was minimal. But the car payment had a bone-crushing effect on my cash flow.
I HATED the payment!
I Screwed Up (so take it from me)
Having no car payment is empowering. The cash flow opened up by a lack of car payments gives you flexibility to invest and grow wealth.
I forgot how shitty car payments are after 11 years of not having one. Mathematically, I was ahead by investing in dividend stocks yielding more than the loan rate. That’s how I justified it. The math was sound, but the payment made me feel poor.
We’re a one income family. So our cash flow is important.
The low rate made the loan somewhat tolerable from a numbers standpoint. But it strangled my cash flow.
As a result of this mistake, I’m swearing off car payments for the rest of my life.
That sounds well and good. But I need to ensure I won’t fall into the low-rate trap again by starting to save now for the next car.
To help you avoid car payments for the rest of your life, I’m going to lay out, specifically, my strategy for eliminating the Odyssey payment and how to avoid getting one in the future.
Eliminate Car Payments With a Lump Sum for Low-Rate Loans
Eliminating car payments seems as straightforward as paying off any old debt. Snowball or avalanche, right? Either of those strategies is fine for higher interest rates. But I deployed a different strategy for paying off this car loan. Since the rate was so low, the monthly interest cost was minimal. So I was comfortable letting it ride until I built a lump sum to pay it off.
Why pay it off with a lump sum?
Mainly to manage risk. If I aggressively paid down the loan each month, I’d make progress on the balance but spread myself a little thin on flexibility. Paying down the debt early wouldn’t actually save any money since a good money market account yields more than the loan rate of 0.9%.
Building the payoff fund came mostly from cash flow, a work commission check, and an extra paycheck (I’m paid bi-weekly so I get 26 paychecks per year). I also sold Caterpillar (CAT) and moved the proceeds to cash.
By waiting until I had the cash to pay off the loan, I maintained flexibility in case a more urgent need for the money emerged.
Once I had enough cash to pay it off, I reevaluated my decision to make sure it was correct. That’s what I did last week.
One way to look at paying off debt is as an investment and return on cash flow. By paying off the loan, I was making an “investment” of $12,852.20 against the loan balance. That payoff amount would yield $563 in cash flow every month, or $6,756 per year. Even though the interest rate was just 0.9%.
$6,756/12850 = 53% annual return.
From that perspective, it makes total sense.
But that return is only for 21 months, the time left on the loan. More importantly, I can take the $563 and invest that amount.
Now, of course, I could alternatively take that $12,852.20 and invest it in dividend stocks for the next 21 months. I can easily find stocks that yield higher than 3%. Or I could invest it in Lending Club notes. So why not?
I have a one-word answer for that:
The car payment was weighing on cash flow AND my brain. So I threw out the math and just paid the damn thing off.
I’ve never regretted paying off a debt.
My Rate was Super-Low… Yours Might not be
First of all, if you spent too much money on a vehicle, darlin’ you gotta sell the truck! I don’t have a rule of thumb here. Don’t be stupid about it. If you make $50,000, don’t buy a new BMW or Acura. Buy used or something new and cheap. Never lease a car.
If your interest rate is higher than, say, 4%-5% or so, you could start paying the debt down on a monthly basis instead of a lump sum. Assuming you don’t have higher rate credit cards or other debt somewhere else. Don’t dig into your emergency fund to pay it off.
If your rate is higher than 5%+ and you can’t pay the loan down quickly, you might benefit from looking into refinancing the loan. LendingTree is one reputable place to get competitive rate quotes. I used it for refinancing our house. Quotes are free.
Or don’t bother refinancing. You can use the high interest rate as motivation to get your ass in gear and pay the thing of.
Eliminating car payments from your life may take a few years. Work to pay off your current car and drive it into the ground. Then plan carefully for how you’ll pay for the next one.
How to Avoid Car Payments for the Rest of your Life
You can move somewhere you don’t need a car. Obvious… probably doesn’t work for most of us. Another method is to drive your current car for as long as possible. Maintaining a car is usually way cheaper than buying another. But eventually, it will become unreliable.
As I was signing the paperwork for the Odyssey, the financing guy pushed a hard sell on an extended warranty.
He had a solid pitch. The warranty would cover just about anything that could go wrong for eight years. I negotiated his price for the warranty down from $2400 to about $1300. But I didn’t buy it.
The salespeople talked about how reliable Hondas are. Then here’s this guy telling me all the things that could go wrong!
The pitch angered me. So in response, I started my own “warranty” fund. I put $1,500 of my own cash into a new high-interest savings account to set aside for major maintenance issues. Each subsequent month I automatically added another $100 to the account. Over time, the fund should grow to sufficiently fix any major issues, AND build the fund to eventually help purchase our next car. This fund is on top of my normal emergency fund.
Not to mention, it saves the price of the warranty. The guy selling it said about 85% of his buyers get the extended warranty.
But now that I’m never getting another car payment ever again, I’ve upped the monthly savings amount to $200. I estimate that about 6 years from now when our CR-V is ten-years-old, we’ll have $15,000 (minus any serious maintenance issues that could arise) saved for a newer car.
That gives us a nice cash chunk to put down on a new car. Our next car will likely be more of a commuter car suitable for a teen driver. Maybe electric?
The downside to saving so much cash for a future car is that the return on cash is capped at the money market’s interest rate. I’m comfortable holding cash even at low rates. It’s still a small percentage of my net worth. More challenging is having the discipline to not touch it. In a pinch, it can always be moved around, but that defeats its purpose.
Build a car fund to simplify your life by helping to eliminate car payments. It decreases overall personal financial risk and gives you that warm fuzzy feeling that you’ll never need to finance a car again.
Paying off a low-rate loan early and creating a cash account to pay for the next car may be too conservative for some readers. I get that.
Perhaps I’m foolish to pay off 0.9% financing. As I said, by the math, I’m wealthier since the investments performed. Sometimes they don’t.
But paying off the loan frees up a lot of monthly cash. Cash flow is king.
The strengthened cash flow position will help me grow wealth and investment income between now and the year I need to buy another car. Before then, my day-job income should increase, Mrs. RBD may start working again, and we should be in a better financial position overall.
Most of all, I paid this loan off to be more comfortable with our financial lives. We try, at every turn, to give ourselves more flexibility to pursue the lifestyle we desire. We want fewer things, more free time, and more options for our family’s future. Eliminating this car payment was a corrective step toward our end goal.
Have you eliminated car payments from your life or fallen into temptation? What’s your take on minivans and the suburbs? Am I crazy for spending so much on a vehicle?
Featured photo via Pixabay CC0 Public Domain.