How to Buy a Car for Cash

I've said that people need to buy a house they can afford as part of an overall, money-savvy plan when purchasing a house, but I don't think I've ever posted anything similar about buying cars. Then I saw this information from MSN that says people are extending their car payments out farther and farther in order to be able to afford the car they want, and I knew I had to say something. The details:

Buyers are paying more, extending loan terms and making smaller down payments, according to a recent study by the Consumer Bankers Association. Many buyers also wrap old loans -- for vehicles they haven't yet paid off -- into the terms of their new deals.

About 60% of buyers are opting for loan terms of more than five years, the study said.

"It's been steadily stretching for many years," says Elmendorf. And it's because buyers want to get a better-quality car and still keep their payments low.

Can I just say, "Yikes!"

Before I comment further, let me include some good advice this article gives:

"They're stretching in a lot of cases and may be well advised to pick a more affordable model or keep their car a little longer," says Fritz Elmendorf, the vice president of communications for the bankers association.

It is a very, very, very bad idea to plow money into a high-cost, long-term purchase that depreciates quickly. It's even a worse idea to extend the payments so you maximize the amount of interest you pay on the debt.

Instead, let me offer this series of suggestions for how to buy a car:

1. Start by spending less than you earn so you have a reasonable cash flow to generate some savings.
2. Pay off your current car asap. Put any extra money towards getting rid of this debt.
3. Start saving for your next car now. Put away at least the same amount as your old car payment and preferably more.
4. Drive your current car as long as you can (which is the time when major repairs start to hit.)
5. When your old car is as old as it can be and isn't useful any more, sell it (if you can get anything for it).
6. Take your savings and the amount you got from selling the car and buy a good, reliable, used car. If you need to take out a small loan to do this, it's ok -- just make sure the loan is substantially less than the loan you had on your last car.
7. Repeat steps 2-6 over and over again until you can pay cash for a new car (if you want a new car, that is.) From here on out, you'll have no car debt.

This is what we did, though we live well below our means so we only had to go through the cycle once. I know many people can't do that (or choose not to based on their current spending), but if you make a good deal of progress on each car you buy, the debt for every new one should be less and less until it disappears altogether.

Comments

[Blaine Moore]

This is something that I am currently pondering.

I got side-swiped by a tow truck last summer. Their insurance covered the costs of fixing it, but when another problem came up a month later (the time that it took for enough power steering fluid to drain through a crack that it became noticable) the insurance company didn't think it was related and wouldn't pay. So I put $800 to $1k or so into fixing the truck up.

I went to get the brakes replaced last week, and rather than costing the $300 or so that I thought that it would, it will cost $1200.

I'll be needing to purchase a "new" (as in different, new or used) vehicle in about 3 years anyway when my wife and I start having kids.

I really like my pickup truck (even if it isn't appropriate for a Maine winter with it's 2 wheel drive), I really like not having a vehicle payment, and I have more than enough in the emergency fund to pay for the new brakes.

I need to figure out whether it is worth it, though, when I plan on getting rid of the truck in a few years anyway and could put the money towards a better down payment.

I'm going to delay my decision in the near term. My wife's grandparents aren't driving any more so I am going to borrow their car for a few months while we look around at what's available for year old vehicles. Their car will be safer than my truck would be anyway, even if it had new brakes.'

I was hoping to pay cash for the car in a few years, though, and go without getting a loan. At least my bank offers a loan that is at a lower rate than my mortgage (and is about half what the rate on my truck was before I paid it off 3 or 4 years ago).

[Terrence]

It actually amazes me how people will throw money at a car they can't afford.

I have a pretty high income, well into six-figures, but I still drive my now 6 year old Honda Accord. When I purchased it, I paid for about half of it in cash. The other half I borrowed because rates were low, and I didn't want to come up with the entire 21K purchase price. I paid off the car in 1.5 years and haven't had a payment since. I plan on having the car for at least another 3 or 4 years.

[Becky]

This is EXCELLENT advise! I just got married this past summer and neither my husband nor I had loans left on our cars. We're saving now and hope to never have a car loan in our married lives.

[Scott]

This one is so easy yet so hard. The logic is so easy because it makes so much sense (I paid cash for my last vehicle) but most people I know do not want to make the sacrifices that are required to make it happen. I have lots of friends who make half (or less than half) of what I do but they all have nicer cars than my Ford Focus. Ultimately it is about "true want vs. true need".

Blaine,
It sounds like you are on the right track but I'd get a second opinion on that $1200 brake job. I'd also recommend trying to fix the brakes yourself as it is a good DIY job.

[Matt]

Shopping your loan carefully can help. Pentagon Federal Credit Union (which just about anyone can join by joining the NMFA) is advertising used car loans at 5.29% APR.

That's only 54 more basis points than the interest you would forgo by spending your Emigrant Direct savings (4.75% APY) on a car. That means over the course of 36 months on $10,000 borrowed, taking the loan would only cost you $79. Throw in the $20 NMFA membership, and we're still only talking a hundred bucks. Not bad.

I think I would take that loan even if I had the money saved, just because it leaves my savings account as an emergency fund. That's important so that I don't end up with credit card debt if an emergency arises.

[Chris]

I think a lot of people simply fail to consider risk whenever they take out a car loan. Everyone who finances a car believes in their heart that they will pay back the loan but they never plan for the unexpected. They never consider what can happen if they can't make the payments. When you pay for a car in full, you don't have to worry about repayment and you can truly save your money for a rainy day. The bottome line is that if you can "afford" a monthly car payment, then you can "afford" to save up for a few months and pay for a car with cash.

[JB @ GetRichOrDieTrying]

This is a nice idea... but what if you're just starting out. The situation my GF and I were in about a year ago was this. She was driving a car that was a few years old with no payments... she got into an accident and got about $1200 out of the deal. What do you do then? We didn't have any money saved up (we were both working our way through college).

Here's what happened... we bought a 1988 Nissan Maxima for $800, drove it for 3 months... got some more money from a student loan and upgraded to a 1992 Nissan Stanza... got hit by another car which made it very dangerouse to drive this car... I got my first real job and decided to go ahead and get a car loan for a decent semi-used (2005) Toyota Carolla. That's real life.

[Lord]

Starting out is a different story.

I wonder how many of these people believe they are financially wise and have all their other affairs, emergency fund, retirement, etc., in order. I wonder how many of them consider paying off their mortgage early. However many it is, it is far too many.

[Blaine Moore]

Scott,

I shopped the job around and everybody came up with the same amount w/i about $30-$40 price range.

The problem is that the parts that I need cost $178 per tire from Ford, and since the entire brakes system on all four tires needs replacing it is a little past my expertise. If it is going to take my garage 5 hours to fix this, then it is going to take me more than that because I don't have the tools or the knowledge of what to do or the garage. Given the 8 inches of snow that fell this morning, I have no interest in getting underneath of my truck right now to teach myself how to do it.

Hopefully the roads are in good shape this weekend so I can drive up to my in-laws and swap my truck for their father's car, and then I'll have a safer vehicle for the winter anyway and I can spend some time looking without worrying about going off of the road.

[J in FL]

Personally, I think this is great advice... Dave Ramsey has a plan that goes something to this effect, and that's one of the things I agree with him about. Of course, putting this into practice is not quite as simple.

[Anitra]

I think the hardest part for most people to swallow is that to make this change, you have to be willing to drive a car that costs less than the car you are driving now. If you always buy new, you'll have to buy used instead. If you already buy used, you need to step down to either a cheaper or older car. If you're already driving a junker, why the heck is it financed? Pay that puppy off and start saving for the next one.

[Scott]

Blaine,
It sounds like you did your homework and I don't blame you for not wanting to work in the snow. :)
Good luck with your truck.

[GLM]

We always aimed for 4 year loans and I think we always managed to pay the loan off early when we were younger and needed an auto loan . After years of tutoring my kids I never thought I'd let them take on any loan over 5 years - preferably 4 . However never say never.....

Last week we took daughter (age 22) who is graduating in two weeks with a BS in Chemical and Biomoleculear Engineering out to purchace a new car better suited to where she will be moving,and with the hope that a new vehicle would be more reliable for her - soon to be living 800 miles away from family.

She bought a car with 0% financing. As such, I advised her to forget the down payment she was planning on (besides the 2K trade in ) and to take out a CD with the funds. It can be the seed funds for her next vehicle and serve an emergency fund back up - good for a new grad that has furniture and everything to acquire. Her resulting payment at 72 months equals what it would have been with the 60 moth loan and the down payment. Now she will have the interest on the down payment cash she held on to and have the funds if a really big emergency arises.

This would only work well if you don't spent the cash retained - I know she can resist - and a CD and resultant penalties will reinforce the concept. She has no other debt - due to years of preaching from me. Her planned budget is includes regular savings as well as 10% to retirement plus and employer 6% match. Ahhh it all looks so good on paper....sigh.

She also learned with astonishing clarity how easy it is to get a loan with no proof you can afford it and therefore get way over your head in debt. ( I told her to remember the same is true when buying a home - they don't care if you can afford it - they just want to make the sale. ) She has an excellent credit score but only documented her very part time work for $9 / hour. (vs the salary at her job that starts next month ) She was shocked they agreed to give her the loan . They never even hesitated and I did not know they gave 72 month 0% loans.

[Elliott]

When we bought my last car, we put half down in cash, and financed the other half. We were given the option of 12, 24, 36, 48, or 60 month loans--all with exactly the same interest rate. No early payoff penalty. I double checked with the agent to make sure I wasn't missing anything--nope, doing the 60 month loan *AND MAKING THE EXTRA PAYMENTS* was equivalent to a 12 month loan. The only difference is that IN AN EMERGENCY, you weren't compelled to make a larger monthly payment.

This is an interesting approach, but if you don't have the self discipline to make the extra payments every month (or more frequently), locking yourself in to a shorter-term loan may be better for you. What makes sense financially doesn't always jive with what makes sense emotionally, it seems.

Either way, we polished it off in a tad over eight months. Feels great to own it flat out.

Now for the house...;)

[InTheWest]

I have always driven a car that I could afford to pay for in cash. When I was younger I drove several $500 and $1000 cars. I eventually ended up with recent model used cars. My last two cars I purchased new including a 2007 Honda Accord EX. What has not been mentioned here is that when you get a car loan they require collision insurance - very expensive and not really that good of an investment. I suspect that high deductibles and no collision insurance has helped to pay for at least a quarter of the money I've spent over the years buying cars. Your mileage may vary.

[Carol]

Great post today.
I have never owned a new car -- to me it is a pointless expence -- and only once have I had car payments.
Forty years of driving and saving.

[Sell Your Car]

Owning a car can get really expensive unless you know what you are doing, In any case, this is a great advise. Thanks for the article! If you need to sell your car, see this sell your car guide

[Susan]

Very useful tips for car buyers, one has to be very careful while owning a car. Here we need a double check with a car seller. Your suggestions are easy to follow when it comes to savings and taking loan for a car. Good observation, thanks a lot.

[PE]

I got tired of making car payments over a 3 to 5 year time period. I bought my car from a friend and got them to finance it at 0% interest for 1 year. It was a $2000 car that was worth $4000. It was not the greatest car but it is reliable and it gets me from point A to B. It is paid for and has been the best car purchase decision I have ever made. You can't beat paid for.