When Thomas J. Stanley and William D. Danko wrote “The Millionaire Next Door,” they did a lot of research. One of their surprising discoveries was that many millionaires buy used cars.
They generally don’t buy junkers, of course, but they might, for example, buy a used Mercedes instead of a new one. As pointed out by USA Today and others, buying a two-year-old car typically costs 25% less than buying new, and at that point the car is still under warranty.
That’s smart, and it might help explain how some of the people interviewed became millionaires.
The other thing millionaires do is pay cash for cars. Let’s take a look at why that’s important, and then explore how you can do the same.
Why You Shouldn’t Go Into Debt To Buy A Car
In general it’s a bad idea to go into debt to buy anything that goes down in value. Borrowing might be a good idea for things that save you money or make you money, including businesses, investments, and (sometimes) houses and education. But not cars.
Sadly, recent statistics show that, not only do a lot of people borrow to buy a car, but when car buyers trade in their old car to buy a new one, a third of the time they’re “upside down” on the loan, meaning they owe more than what the car is worth. That complicates matters, to say the least.
Even if you stay “above water” on your loan there is another problem: Borrowing means you pay more, and that’s not smart. In fact, you pay more in at least four ways…
- You Get a Worse Price – When you borrow to buy, you lose the negotiating power you would otherwise have as a cash buyer. My wife and I walk away from dealers a lot when we shop for a car, and believe me, they come running after you offering a better deal when you have cash.
- You Pay Loan Fees – There are loan fees and other costs that come with a car loan, For example, loan origination fees are typically 2% of the loan amount, so if you borrow $20,000, you’ll pay $400 just for the privilege of going into debt. You might also be pushed to buy loan insurance.
- You Pay Interest – After paying a higher price for the car and fees for the loan, you might also pay thousands of dollars of interest over the years. This is usually the largest additional cost of borrowing to buy a car.
- You Give Up Other Money-Saving Options – Some of the best car deals come from private sellers, but many of them are hesitant to wait for you to get financing. Cash usually gets the best deals As a cash buyer. you also have the option to save money by skipping expensive collision insurance, which you’re not allowed to do when you borrow (lenders usually require a certain level of coverage).
You might, after all the upfront costs and added interest, shell out $4,000 or even $5,000 more for the same car when financing it versus paying cash.
To save money is a good reason to avoid a car loan, but beyond that there is also the general problem of burdening yourself with debt. As explained in my post “How To Buy Freedom For Less,” having extra fixed expenses like car loan payments limits your options in life.
Convinced that it’s better to avoid the debt? Then let’s look at….
How To Pay Cash For Your Next Car
If you can really afford an auto loan payment you can also afford to skip the loan and save up the money needed for your next car.
Sure, it may not be simple. You might need that next car now, or you may need a nice car and your cash will only get you a junker. But there are ways around these problems, so let’s take a serious look at six strategies you can use to pay cash for your next car.
1. Buy Used
Kelley Blue Book says, “More than two-thirds of new-car buyers finance their purchases.” Notice that they say, “new-car buyers.” New cars cost more than used ones, of course, and buying for cash is easier if you look at lower-priced used cars.
Many experts say three-to-four-years-old is the “sweet spot” for used cars. At that age you might find a car for close to half the original price, and it will have much more than half of its functional life left.
On the other hand, Edmunds says buying a one-year-old car is the way to go, because that first year sees the biggest drop in market value (sometimes as much as 25%).
In general you’ll save money upfront and in the long run with a used car. For example, Edmunds calculates that the total out-of-pocket costs (repairs, maintenance, insurance, gas, etc.) over five years of ownership are more than $8,000 less when buying a 3-to-4-year-old compact SUV versus a new one.
2. Buy A Cheaper Model
Whether you get a new car or a used car, one way to make a cash purchase possible is to buy a model that’s inexpensive. Most small sedans cost less than most SUVs, for example, and there are also big price differences from model-to-model.
Of course, you still have to get what you need, but there may be room for compromise. Instead of a large pickup you can buy a smaller, cheaper model, for example.
You might also consider the long-term operating costs. Consumer Reports has data on the least (and most) expensive models to own based on total expenditures over five years.
3. Skip The Dealership
In some ways it’s riskier and more trouble to buy a car from a private seller. After all, there is nobody but you to handle the licensing and plating of the vehicle, no trade-in (you have to sell your current car yourself) and no three-day return guarantee (as some dealers offer).
But one thing is certain; the best prices are found with private sellers. For example, according to Kelley Blue Book, a 2015 Hyundai (our current car) has a “fair purchase price” of $8,678 at a dealership, versus the “private party value” of $7,625.
Not only is there a price difference of a thousand dollars, but there are fewer other costs with a private party purchase. For example, dealerships typically have document fees of $300 to $500, and sometimes sneak in other inescapable fees.
4. Find Sources Of Money To Save
If you have considered getting a car loan, and you feel you can afford the payments, you should be able to, instead, set aside and save whatever those monthly payments would have been. Just keep your current car going for as long as possible, and put that $300 or $500 per month in the bank.
In addition, make a point to set aside any extra income or non-budget money for the car. This might include things like…
- Cash gifts
- Income from extra shifts at work
- Tax refunds
- Cash back from credit cards
You get the idea. If it’s extra, don’t blow it on entertainment or buying more stuff — set it aside for that car!
And while you’re at it, speed up the process by seeking out more of these extra income sources. Something as simple as renting out a bedroom can bring in thousands of dollars in one year. One overtime shift every month might net you another couple thousand annually.
You can also save the money freed up by reducing your expenses. For example, if you drop a $30-per-month gym membership in favor of walking more, you can save another $30 monthly toward your next car purchase. That leads us to the next strategy…
5. Go Carless To Save For A Car
You might have a problem saving for that next car while still paying the expenses of the one you already have. In that case, the solution might be to go without a vehicle for a while.
The statistics show that millions of people in the U.S. survive without a vehicle, so maybe you can too. Even if you’re not in one of the cities where it’s easiest to live without a car, you might get by with a bicycle and public transportation.
Where my wife and I live, in Tucson, Arizona, it costs just $40 for an unlimited bus pass. Even if we both bought passes, and then rented a car once a year for a vacation, and used Uber a few times, the total cost for our transportation would be cut in half versus owning our car.
AAA says the average cost to own a car in 2018 is $8,849 per year. So you can get by without a car for a while you might be able to bank $4,000 annually in savings. That quickly puts you in a position to pay cash for your next vehicle, especially if you buy used.
6. Put It All Together And Pay Cash
If you have a plan and follow through, you should be able to buy a car for cash within two years or less. The idea is to spend less and make a little more, in order to save a big chunk of change every month.
Of course it might take you more or less time depending on your income and the type of car you want (at 18 I bought a drivable car for $50). But let’s look at a hypothetical example based on the goal of buying a nice car for cash in 18 months, instead of borrowing to buy now.
- Save the $400 car payments you would otherwise have: $7,200
- Save your next tax refund: $2,400
- Earn and set aside a bank bonus: $300
- Sell a bunch of stuff you don’t need: $800
- Work an extra overtime shift ($125) once monthly: $2,250
- Find frugal strategies that allow you to save another $100 per month: $1,800
- Use some of our 115 ways to make money at home to make $125 monthly: $2,250
Make sure you have a separate account for that car money, so you’re not too tempted to dig into it for other purposes. The total in the example adds up to $17,000 by the way, which is more than enough to buy a nice used car.
Oh, and keep that separate savings account going after you buy the car. After all, you’ll need another vehicle someday, and there’s no reason not to pay cash for that one too.
If you pay cash for your cars, tells us how you do it below … and keep on frugaling!