For many people, the idea of paying cash for a car seems ludicrous.
It might seem like something only rich people can do, like doctors and lawyers and Beyoncé.
Our culture loves to make payments on things, and it never occurs to most people that paying cash for a car is even an option.
And if I had to guess, I’d say it’s likely you don’t know anyone who has ever paid cash for a car, and that alone makes it seem all the more impossible.
But when it comes to our financial security and our overall ability to build wealth, paying cash for a car is absolutely a smart financial move.
Don’t believe me?
Let’s take a moment to look at how paying cash for a car affects our lives.
What Really Happens When You Don’t Pay Cash For a Car
If few people actually have the money to pay cash for a car, how is everyone able to drive all these fancy vehicles I see all over the road?
Oh yeah. Financing!
The vast majority of people are stuck in a cycle of financing one vehicle after another, essentially for the rest of their lives.
Unfortunately, from a financial perspective, this is a really lousy way to own and operate a vehicle.
There are 3 main reasons why financing a vehicle is a horrible financial choice.
1. Auto Loans Aren’t Free
Let’s say you’re going to finance a nice used car.
You shop around and find a car you like and haggle with the dealer to get the price down to $15,000.
But when you finance it, $15,000 isn’t the real price you’re going to pay for that vehicle.
You see, loans for $15,000 aren’t given away for free. And the price of that loan is often a very hidden fee that most people never see or even think about.
The total price of the loan is determined largely by the interest rate you get on your loan.
In this example, let’s say you borrow $15,000 at a 10% interest rate.
Over a 5-year payback period, you’ll actually end up paying $19,122.34.
That $15,000 loan will cost you $4,122.34. Whoa!
But most people who finance cars don’t look at the cost of the loan. They just think of that $15,000 they settled on with the dealer.
We know this because if we ask this person how much they bought the car for, they’ll say $15,000. Nobody ever says, “The price was $15,000, but the loan is costing an extra $4,000 so the car really cost around $19,000.”
Have you ever heard anyone say that? Me neither.
The truth is, financing a car is a lot more expensive than just paying cash for a car.
2. Monthly Payments Cost More
When you choose to finance a car, you “get the opportunity” to pay a regular monthly payment.
In the example above, that payment will be $318.71. Every. Single. Month.
For 5 years!
$300 is certainly less than $15,000, but month after month, that is a healthy portion of your paycheck that is being eaten up.
That’s $300 every single month that you can’t use to…
- pay down your credit cards
- buy groceries
- go out to eat
- buy clothes for your kids
- get Christmas presents
- take a vacation
- put gas in your car
- pay for a babysitter
- buy tickets to a concert
- or hundreds of other things.
That $300 payment every single month is costing you the opportunity to do many other things with that money.
One more example? That’s $300 every month you can’t use to save up money and invest to build wealth.
The truth is, having a car payment is costing you a lot more than just the dollars that come out of your bank account each and every month.
3. It Takes Money to Grow Money
We all know interest payments can work in two different ways.
You either make interest payments to someone else (bad), or you have interest payments paid to you (good).
You can borrow $15,000 for a car, and you’ll be making interest payments to the bank.
Or you can put $15,000 in a high-yield savings account and the bank will make interest payments to you.
Guess which one financially savvy people do?
The problem isn’t that you can’t do both. The problem is that it’s incredibly hard to do both.
Most people end up doing one or the other. One happens through discipline. The other happens through negligence.
If you’re borrowing money on a regular basis you’ve probably noticed it can be really hard to also save up money that can be used to grow you even more money.
And not being able to save money ends up costing you more money in 2 big ways.
- You don’t have the necessary cash saved up when an emergency comes up, causing you to borrow even more money and pay even more interest.
- You don’t have the ability to invest money to earn interest and grow your money over time.
Those two items are really big deals when it comes to being able to build both financial security and wealth for retirement.
What Happens When You Pay Cash For a Car
Now that we’ve seen the 3 big drawbacks to financing a car, let’s look at what happens when you pay cash for a car and see how those results are different.
1. You Pay Less
This time, you shop around and find a nice car that you want.
You haggle with the salesperson and settle on a price of $15,000.
You use cash and pay $15,000.
Without having to pay the additional cost to borrow money, you just saved thousands of dollars in interest payments.
2. You Avoid Monthly Payments
By paying cash all at once, you have no monthly payments following you around for years and years.
This means that when your paycheck hits your bank account, you get to keep your own money!
Can you imagine that? Getting paid and not having all your money sucked away by debt payments?
In this case, that’s an extra $300 every month that you can use to do…well…whatever you want.
3. You Gain the Ability to Grow Your Money
With an extra $300 available every month, you’ll be able to save up money to build a healthy emergency fund.
That means when the A/C breaks down, or a hail storm damages your roof, or you get in a fender bender in the Walmart parking lot, you’ll be able to pay cash to fix the issue instead of having to rely on a loan and paying more interest to someone else.
It also means you’ll have the ability to invest more money in your 401k at work or your Roth IRA at your investment firm to grow your money for retirement.
The truth is, building wealth is so much easier when you pay cash for a car and don’t have a car payment eating away your money every month.
How Do You Get Started Paying Cash for a Car?
“That all sounds great, Aaron, but how am I supposed to start paying cash for a car when I can’t save any money?”
You’re likely not in a position to start paying cash for a car right now, and that’s ok.
But that doesn’t mean that you can’t start preparing to be one of the crazy awesome people who pays cash for a car in the future.
Here are 3 steps you can start working on today to get yourself set up to be a cash-paying genius in the future.
1. Pay Off Your Current Car Loan
It may seem obvious, but in order to pay cash for a car, you’ll need to save up the money first.
That’s really hard to do when your money is being gobbled up by your current car payment, so the first thing to do is get your current car loan paid off as quickly as possible.
Once your current car loan is paid off, take the monthly payment amount you were paying to the loan and start putting it in a savings account every month. Pretend you still have a car payment, but now you’re paying yourself instead of someone else.
2. Start With a Cheaper Car
If you’re used to buying brand new cars or used cars that are only a few years old this might be a bitter pill to swallow, but you don’t have to pay a lot of cash for your first cash car.
It’s possible to find decent used cars for as little as $5,000 that you can drive for 2 years before upgrading.
The car may not be as nice as you’re accustomed to, or even the exact car you want but that’s ok. This is more important than that.
You’re creating a new money habit that is going to trickle down into every single aspect of your financial life!
So if your car status takes a hit at first, it’s ok. It will sting less when you’re a millionaire. Trust me.
So let’s say you’re saving $300 a month after paying off your current car loan, and you drive your current car for another 2 years.
$300 a month x 2 years = $7,200 saved in your car fund.
Now you find a $7,000 used car and you pay cash for it. You then sell your old car and get $4,000 for it.
Now you’re driving a $7,000 car and have $4,200 saved in your car fund.
3. Rinse and Repeat
Now you keep saving $300 a month for 2 more years.
That’s another $7,200 to add to your $4,200 in savings for a total of $11,400.
Then you buy a $10,000 car for cash and sell your old car for $5,000.
Now you’re driving a $10,000 car and have $6,400 in savings.
Then you drive this car for 2 years and keep saving that $300 per month.
Now you’ve got another $7,2000 to add to your $6,400 for a total of $13,600 saved in your car fund.
That’s a total of 6 years that you haven’t had to pay any interest on a car loan. The result?
You’re driving a car you can probably sell for $7,000 and have over $13,000 saved up in your car fund.
In just 6 years you’re in a healthy financial position to buy a $15,000 car for cash and still have $5,000 leftover.
And you can just keep doing this over and over again, and you’ll keep having more and more money for a car, and more money saved up to pay cash for any necessary maintenance.
Your dependence on a car loan will literally disappear forever.
How crazy is that??
Financing a car may feel like it’s providing a cheap way to afford a nice car, but the truth is it’s costing you so much more than you realize.
If you can wrap your mind around the idea of paying cash for a car, your ability to save money and grow your financial security will take a huge leap forward.
It may feel odd at first, but once you get accustomed to your new normal of paying cash for cars, you’ll never go back to being chained to a monthly car payment ever again.
Don’t Miss These Related Posts:
Caroline at Costa Rica FIRE
Agree 100% that you need to look at the car loan interest rate b/c they can be high. Also agree 100% that you don’t want to rely on financing for something like a car which depreciates as soon as you drive it off the lot. However, if you have excellent credit, you can get financing at crazy rates. We did finance our car — .99% for 5 years. The cost of the financing is less than inflation so we’d rather have a small monthly payment over time and use a lump sum for a higher yielding investment. We also are majority real estate in our portfolio so we have a lot of our net worth already illiquid. Stretching out the car payment gives us liquidity which is particularly valuable to us.
Live Your Wage
Great points, Caroline. For those like you who already have a solid financial foundation, there are times when financing won’t hurt as bad, and may even help, like with your cash flow situation. But there are other times, like when there is a recession, the economy slows, or we lose our job for an extended period of time (like right now) when having that car payment can come back to bite us. With a healthy emergency fund, a lot of the downsides may evaporate, but when someone is just starting to take control of their money and build their financial foundation, I encourage everyone to ditch car payments.