Simple Car Buying Rules That Can Save You Money
November 25, 2013I recently received a nice reminder about why our family maintains an emergency fund. While sitting in a car line getting waiting to drop my daughter off at school (and trying to play the role of referee during an early morning brother/sister quarrel), I noticed that the SUV was severely overheating. A few days and about $1,300 later, my daddy chauffeur business is now once again back up and running. (Note: I am still working on getting the cute little monsters to get along though.)
Major car repairs often create a dilemma, especially if you have an older vehicle. Does it make more sense to spend money to have necessary repairs completed or is it best to just go ahead and buy another vehicle? My personal philosophy is to drive vehicles as far as they will go while still maintaining a certain degree of safety and reliability for peace of mind, knowing I often have precious (albeit mischievous) cargo on board. In our situation, we still have a lot of miles left on our vehicle and getting the repairs done was more appealing than trying to trade in a vehicle in need of repairs, which would drive down the trade-in value.
Eventually, I know that our vehicles will need to be replaced. My wife is self-employed as a pediatric occupational therapist and she puts around 25,000 miles on her car per year making home visits and traveling to conferences. That’s why we’ve included some simple car buying rules into our financial plan. Here are some of the highlights:
Create an emergency fund. This is a proactive rule that is a must for everyone regardless of whether you are looking to buy a car or not. The most common emergencies in life usually tend to be the most expensive. Medical and dental emergencies, car repairs, home maintenance repairs, and loss of employment income are difficult situations both emotionally and financially.
It helps to have a safety net in place and that’s why most financial planners will recommend keeping at least 3-6 months’ worth of basic living expenses in a separate account from your day-to-day checking. If you have consumer debt such as credit cards or existing car loans, it usually makes more sense to make extra payments towards the debt before fully funding an emergency savings account but you still should at least try to build a starter fund of at least $1,000 before you start aggressively attacking debt. Otherwise, you will end up racking up more credit card debt when the car breaks down or some other “life happens” moment occurs.
Create a car replacement fund (especially if you have an older and potentially less reliable vehicle). It’s important to keep this replacement fund separate from your emergency fund. If your car needs replacing before you have your replacement fund setup, you can always dip into your emergency fund. Just be cautious not to deplete the fund entirely. You can use this Saving for Goals calculator in conjunction with your budget to help you figure out how quickly you can reach your savings target. A Planned Spending Account system can also help you make sure you are setting aside money each month for irregular expenses as well as specific savings goals such as an emergency fund or car replacement fund.
Don’t pay attention to the monthly payment amount. Sometimes our best plans fail and life events happen that challenge our belief system. If your plan to build up a car replacement plan gets blindsided by an unexpected breakdown, new addition to the family, or some other reason to buy another car sooner than expected, you should still avoid making some costly mistakes like buying more car than necessary. Just because a car payment “fits into your budget” doesn’t necessarily mean it is a good fit for your financial plan.
If you succumb to the “car fever” virus, you might just get that instant urge to buy a vehicle based on emotions rather than rational thought. Some of the most important financial decisions that we make get derailed by clever marketing, “I deserve this” thinking, and short-sightedness. Look at the total cost of debt rather than just your monthly payments.
Beware of extended loan payment terms. Vehicle loan terms average just over 5 years and consumers are buying more expensive vehicles largely in part due to low interest rates. If you have to finance a vehicle, keep the duration of the loan and interest rate as low as possible. It is also smart to try to put at least 20% down on a vehicle (if you can’t afford to pay for it with cash). If you cannot afford to make a 20% down payment, then perhaps you cannot afford the vehicle in the first place.
Buy a used car and let the previous owner help you lower the overall costs. It’s easy to get car envy when you see the newest and sleekest models of vehicles out on the roads and parked in your neighbor’s driveways.But one thing you don’t always get to see is the balance sheet or monthly payments of the people that drive these cars. I’ve worked with countless families struggling to make ends meet while trying to make car payments as high as $300, $400, $500 or more on a vehicle that lost value the moment it left the dealer’s lot. A new car can lose about 20% of its value during the first year and around 10% per year for the next four years.
Thankfully, my recent trip to the auto repair shop was able to give our vehicle new life. We still have two more years left on our plan to build a car replacement fund so we can buy the next ride with cash. But if everything works according to plan, I hope to drive it another 100,000 miles. Saving $350 per month over a 5-year period at an ultra conservative one percent interest will give us a little over $21,000 (plus any extra trade-in value) to pay for our next used car with cash. As an aggressive investor, I would strive to do much better than that and could see about $23,000 with a 5% average growth rate. I used to think those monthly car payments were just a way of life but now enjoy having a little more freedom and control during the next car buying experience.