If you have never heard of the “Rule of 72” basically it is the way that investors predict when your money will double.
Generally speaking, $1 invested today will be worth $2 in 10 years, $4 in 20 years, and $8 in 30 years. Historically, money doubles every 10 years.
Now, what does any of that have to do with your car payment?
Because whether you are just saving for a wedding, paying off some student loans, or you're planning for the long term having a monthly car payment is a huge liability. In this short 5 minute read I aim to expand on why you should reconsider having a car payment and how I came to this conclusion after my bonehead mistakes in 2014.
[Related: 4 Reasons to Never Buy Brand New Cars.]
Wealthy people drive cars they can afford!
The difference between most people and wealthy people boils down to how they simply view money. Money is just a tool, but for most, we typically look at money in “Present Value.”
- This coffee is only $5
- This rug at Target is only $45
- This new instant pot is only $150
- This new car is WORTH $25,000
But looking at purchases in terms of present value can lead you down the wrong path. Instead, look at purchases in terms of future value. The $5 coffee in 30 years is $40 in 30 years or 8 coffees. The $25,000 car now, is going to be worthless in 30 years, but had that money been invested it would be worth close to $200,000. In terms of present value when it comes to cars, cars depreciate almost 20% in the first year of owning them.
That is like taking $100 and throwing it out the window every week for a year. By year 6 (the time most car loan terms are ending), they are worth 60% less. I tell you this because as I alluded to before, your money will double every 10 years if invested correctly. I can say all of this because the biggest mistake I have made in my life financially has been a new car purchase.
The first thing Lauren and I did when we sat down with a trusted adviser in the area of wealth management and finances in February 2016 was present him with our budget, or spending habits.
As we looked at our budget to free up money, one of the first things we zeroed in on was the monthly car payments. The goal was to increase our monthly cash flow.
At the time, my wife drove a 2012 Kia Forte and I drove a 2011 Hyundai Sonata. Combined we owed about $15,000 on our cars with payments of $500 a month. In other words, we were paying $6,000 per year for our cars not including gas and insurance.
But that is way better than where we started…
My dumb car buying decision.
October 2014: I drove the beauty above, a $37,000 2014 GMC Sierra Double Cab, ego-inflating, carbon fiber edition, decked out truck. I had been hired as an Assistant Athletic Director and I got a huge raise….$4,000 dollars!!!
So with my raise, I finally deserved my first brand new vehicle.
So one day I went to the Honda/GMC dealership to see my buddy who was a mechanic. I had him fix the window motor on my paid off, 2007 Honda Civic Si with only a tad more than 100,000 miles reading on the odometer.
While I was waiting I started looking at the trucks on the lot.
At this time I had about $9,000 in savings and owed another $20,000 on student loans.
Had I had any guidance when it came to finances, the fact I owed that much on my student loans, yet had money just sitting in a whopping .35% savings account literally earning nothing, I should have been focusing on the debt.
Debt is always an emergency.
Impulsive Josh buys a car.
Instead of using my savings on a ring I surprised my girlfriend of two years with a truck!
But hey, I deserved a nice truck for all my hard work and I had good credit so my interest rate was undeniable. Wrong. Banks want your money.
So I bought a truck with no planning and I got $7,000 for my trade-in (they sold it for over $10,000), I used another $6,000 of my savings, and I financed the remaining $24,000. My monthly payments were $368.00.
My new insurance would be $87.00. The V8 engine got 18 city and 24 highway according to the window sticker. I was dumbfounded when that never occurred.
Drive around Northern Virginia for a day and you will quickly realize it is nothing but stop and go traffic 24/7.
In fact, NOVA has some of the worst traffic in the entire country. So in other words, I never got 18 city, more like 10-12 MPG. So monthly I was spending about $180 on average in gas.
Something I never even thought of – personal property taxes in Loudoun County. I got my bi-annual tax bill in December and I owed $330.00 for the three months I owned the truck.
Or, $110 a month. So I had to make sure to save $660 for each June and December.
As you can see in the table above, I went from owning a perfectly reliable Honda Civic with the title in hand to shelling out $532.00 more a month for a truck that I had to use $6,000 of my savings for.
I could have paid $12,384 on my student loans in addition to the monthly payment over the duration of the next year owning the truck.
Two months later I picked up David Ramsey’s book and remembered the quote about buying a new car. He said (as I alluded to earlier) buying a new car is the same as throwing $100 bills out the window of that new car.
I immediately started regretting my decision. Sure $360 sounded affordable at first, but the monthly expenses added up quickly and I was quickly feeling the financial crunch.
I was spending 23% of my salary on a vehicle. I had student debt. Nothing in savings. In fact, we did not even have a written out budget when I decided to buy a brand new truck (Only 32% of Americans actually have a budget written down). Ask 10 people how much money they spend a month on stuff and 7 cannot answer you.
We lost the monthly car payment.
Just like I decided to buy the truck, one day I decided I would sell the truck. Deciding to sell the truck after 9 months of ownership was not bad at all, I was actually relieved. To society, it may look like I was taking a step back.
But people’s opinions will never pay your bills. If you're worried about what people might think, here is some advice: STOP COMPARING YOURSELF. Most of the time they are not thinking about you as it is. Personally, we live life by this motto: You can not have any say with what we do with our finances because you do not pay my bills.
I traded the truck in for the 2011 Sonata. After the trade-in value, the cost of the Sonata, and what I owed on the truck, in total I owed about $4,000 for the Sonata.
I laughed, I had essentially rented a truck for 9 months, forking over my paid off civic (7K), savings (6K), payments (4,000 I paid extra thinking I was doing something smart, really I was spraying my money) to buy a car that I still owed $4,000 on. Had I just kept my civic I would have saved close to $14,000, instead of only having $4,000.
Result of losing the car payment: Cash is King!
Paying off both vehicles between February & November 2016 freed up over $500.00 a month of cash flow. Some people get wrapped up in interest rates.
There is a science behind it, yes. Sometimes it depends on your situation, to be frank. But paying off some lower balance student loans with higher interest rates rather than our cars was not going to free up $500.00.
That extra cash gave us more monthly cash flow to pay off my student loans which were $350.00 a month. Now we had $850.00 cash to attack Lauren's loans. Just like that, we had $10,000 a year to help us pay off our student loans, which is how we paid off $70,000 in 2018.
My key take away when it comes to car payments:
- Eliminating your car payment is important. Auto expenses account for 20% of the average American's budget. Housing is another 40%, so having $6 out of every $10 tied up doesn't give you lots of wiggle room.
- Do your best to lose the monthly payment as fast as possible. Double up so you can free up the monthly payment to use elsewhere (Payoff other debt, save, invest).
- If you lease a vehicle, I would recommend getting out of it, a car lease is almost never advantageous unless you use it for business and can write it off (Lease is really just a fancy word for rent).
- Bluntly put – just because you work hard, doesn't mean you deserve a nice new car. Most people work hard, but that doesn't mean you negate your hard work by tying up 20% of your income in a new car. Personally, I cringe when I see people post their new car on Facebook, then see all the likes and congrats comments.
- When buying cars, ask yourself these important questions.
- A car should never be valued at more than 25% of your annual gross income. As a general rule of thumb when buying a car, it's price should not exceed 25% of your gross annual salary. So if you make $40,000 a year, your max car purchase price is $10,000.
At the end of the day, most people need cars to get to and from work. Even with ride-sharing, public transit and carpooling close to 8 in 10 still use a car to get to work. So while I propose a tough stance on car payments – not having them – I do realize you most likely will be in a car you own at some point in your life.
That being said, you don't have to drive your retirement account around for the next 40 years of your life. As long as you are happy and you can get from point A to point B, does it matter what you really drive?
Question: What would you do with $517 each month extra (Avg. Car Payment)?
Josh writes about ways to make money, pay off debt, and improve yourself. After paying off $300,000 in student loans with his wife in less than five years, Josh started Money Life Wax and has been featured on Forbes, Business Insider, Huffington Post, and many more! In addition to being a life-long entrepreneur, Josh and his wife enjoy spending time with their newborn son, their chocolate lab named Morgan, working out, being outside, traveling, and helping others with their finances! In case you were wondering, Josh uses Personal Capital to track his net worth and his first investment account ever was an Acorns account 😎