Americans love their cars.
Unfortunately we love our cars to the point of having a financial hernia.
Look at it this way: your vehicles are likely the biggest purchases you will make in life that lose equity or value. In fact, as soon as the ink dries and you cruise that “red rocket” off the lot, you’ve already lost as much as 11% of its value!
Alternatively, when you invest in a home, the expectation is that the value will rise over time- meaning you will make money on it when you decide to sell. It’s a different story with a car.
The typical car loses about 15 to 20% of its value each year.
Let’s assume Bob decides to make the jump and buy a new Honda Civic for $20,000 after he graduates college and lands the job. He has little money to his name and has to start paying off his “average” $29,000 student loan soon.
Now that he’s survived school he deserves something nice, right?
He puts the minimum amount down and finances most of the twenty grand needed to buy the car. Slick, the Automart salesperson said that he can easily afford the monthly payments over the next 5 years. Thanks, Slick. Bob thinks that maybe he can finally impress the feisty barista who snubs her nose whenever he pulls through the drive through in his rusted-out hatchback…
Ah, but Bob is making a huge mistake. As soon as he drives the car off the lot he is already upside-down on his love mobile (owing more than it’s worth). Slick didn’t bother explaining that since he doesn’t have a good credit score, nor a long-term income background, the loan was taken out at a 7% interest rate.
Bob’s payment is a manageable $400/month, but what he doesn’t realize is that by the time the car is paid off he will have spent an extra $4,000 in interest.
If someday he decides to sell his car after it’s been paid off, his once-treasure will only be worth about $6,000- after his $24,000 investment. The graph below shows this remarkable trend:
What if Bob had invested that money spent on a car payment for 5 years instead of spending it on this depreciating asset? The graph below shows how investing $400 for 5 years, then letting it grow in an S&P 500 Index fund would yield Bob about $200,000! That’s how much that “cool” car cost Bob.
Leasing? Leasing a car may seem like a good option, especially to the recent graduate who doesn’t have much money. Look at how pretty this is: you are promised a brand new car (which no one has spilled their large coke in yet) for the price of a few happy meals per month. Eh? Ehhh?
Here’s the problem: leasing is essentially the same as renting.
The car doesn’t belong to you, and, once the lease is over, you turn it back in.
You should know the following before leasing:
(1) You have a mile limit- usually 12,000 miles, and huge fees will greet you when it’s surpassed.
(2) If you can’t afford the payments, you are expected to pay the entirety of the lease in order to get out of it.
(3) You will be charged at the end of the lease for “cosmetic damages.” This includes scratches, seat wear, everything. If you know someone who didn’t have to pay damage feed, I’ll dedicate this article to you.
(4) You are literally throwing money down the porcelain throne.
So how do I buy a car?
Simple. Buy used.
Get over your collective exasperated sighs. Buy a used car, Bob.
Here’s why: when you buy a car that’s a year or two old, it’s like getting 20-40% off instantly! This amounts to huge savings for a Drunk Millionaire. Also, a car that’s slightly used will have most of the kinks worked out.
Pay with cash. Don’t finance your vehicle. Americans currently have nearly $1 Trillion dollars borrowed on vehicle loans. Buck the trend and take control of your destiny. Put yourself in the position to build wealth by avoiding payments.
How much should I spend then? The less money you spend on a car now means at least that much more money you’ll have available later to save and use to build your wealth.
Start with a clunker. I drove a $1,800 Civic throughout college. No, it wasn’t pretty.
But I stayed completely out of car debt and it was reliable with excellent fuel economy. Swallow your pride and listen carefully for the good of your future wealth: Stick with a clunker until you have paid off all your debts.
When you pay off the last loan, start setting aside what you would spend in car payments to a savings account called “The Car Fund.” Let this fund build until you can upgrade your clunker with cash.
This sounds simple because it is. It’s called “delayed gratification,” a thought process that has become extinct in America. If you want to keep saving money in this account and upgrade your upgrade car, go for it: I really don’t care as long as it’s paid for in cash.
Now I drive a nice car because I drove a clunker while I had to.
Final advice: Don’t spend more than ½ of your annual take-home pay on vehicles. As long as you stay below this threshold, you should have more than enough room to become a Drunk Millionaire.
Want to learn how to manage your money and become a Drunk Millionaire? Check out our Four-step Program.