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 U.S. consumers. But they don’t have to be, and shouldn’t be even with low interest rates.
Because they crush your monthly cash flow.
According to Experian as of Q3 2018:
- The average loan amount for new cars in the U.S. was $30,977
- The average car payment was $530 over 68 1/2 months
- The percentage of new cars purchased with financing is 85.2%,
- The percentage of used cars purchased with financing is 52.8%.
Financing a car purchase is normal.
The Federal Reserve Bank of New York recently reported that a record 7 million Americans are delinquent by 90 days or more on their car payments. That’s stunning considering the strong economy and 4% unemployment. Worse than following the real estate and banking crisis of a decade ago.
Clearly, not everyone is participating in the strong economy.
It’s also a sign that people are buying more expensive cars than they can afford.
In 2015, I succumbed to the temptation of a low-interest rate car loan after 11 years of no car payments.
And regretted it.
Instead of following the terms of the loan, I paid it off in one $12,852.20 payment. The loan is gone. The title is mine.
And I swore off car payments for the rest of my life.
I’m now using a high-yield money market account to put away $300 each month to save cash for my next car purchase. We expect to need a car upgrade in three to four years.
Why I Financed Our Minivan in the First Place
After 14 months of traveling in Asia and Latin America, I returned home and bought a new Toyota Echo for around $13,000 with no money down and a $221 payment (4.59% interest rate).
I negotiated so aggressively to get that price that the dealership offered me a job after we closed the deal. But that’s another story.
I still hated that payment. So I paid off the 66-month loan in 30 months. That was 2004.
The car gave me nine years of reliable service. Seven of those years were completely 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 awesome.
When we had our third child, three car seats wouldn’t fit into the back seat of the CR-V. 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 a three-year loan. 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. That 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.
But the major downside was that $563 payment. I hated it.
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 Screwed Up (so take it from me)
Having no car payment is empowering. The cash flow released from eliminating car payments gives you the flexibility to invest and grow wealth.
I forgot how shitty car payments were 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, but the payment made me feel poor.
We’re a one income family. So our cash flow is important.
As a result of the mistake, I swore off car payments for the rest of my life.
That sounds well and good. But I then needed to ensure I wouldn’t fall into the low-rate trap again by starting to save up for the next car.
Here’s the strategy I used to eliminate the Odyssey payment and what I’m doing to avoid the need for a car payment 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. 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.
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 a stock I no longer wanted to own 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 before paying off the final chunk.
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 was only for 21 months, the time that was left on the loan. More importantly, it allowed me to invest an additional $563 every month going forward.
Now, of course, I could have alternatively taken that $12,852.20 and invested it in dividend stocks for the following 21 months. I could easily find stocks that yield higher than 3%.
Or I could’ve invested it in real estate crowdfunding to generate higher yields. 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.
My Rate was Super-Low… Yours Might not be
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.
Or don’t bother refinancing. You can use the high-interest rate as motivation to get your ass in gear and pay the thing off.
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
So how you can avoid car payments entirely? You can move somewhere you don’t need a car and Uber everywhere. Obviously… 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 this guy was 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 into savings as a set-aside for major maintenance issues. Each subsequent month I automatically add another $300 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.
I estimate that about 4 years from now when our CR-V is ten-years-old, and after saving for the past few years, we’ll have about $20,000 (minus any serious maintenance issues that could arise) saved for a newer car.
That gives us a nice amount to buy a new or used car. Our next car will likely be more of a commuter car, also suitable for a teen driver.
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, especially now that rates are rising. Overall, the cash is still a small percentage of my net worth calculation.
What’s more challenging is having the discipline to not touch it. In a pinch, it can always be used elsewhere, but that defeats its purpose.
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.
Also, eliminating car payments may seem out of reach for many, especially for those living paycheck to paycheck.
I’m here to say it’s worth it. If not this year, make it part of your long-term plan.
The strengthened cash flow position is helping me grow my wealth and investment income, and our family is well-positioned to buy our next car.
Before then, my day job and side 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?
Photo via Pexels CC0 Public Domain.
Craig is a former IT professional who left his 19-year career to be a full-time finance writer. A DIY investor since 1995, he started Retire Before Dad in 2013 as a creative outlet to share his investment portfolios. Craig studied Finance at Michigan State University and lives in Northern Virginia with his wife and three children. Read more.
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