Conventional “wisdom” says that there’s no way around having a car payment every month. Vehicles are just so expensive that there’s just no way to avoid it. You’re stuck with that huge monthly payment and have to deal with it for the rest of your life.
This conventional wisdom is not so wise after all. It’s simply not true that a car payment has to be a permanent part of life. We can choose to avoid the money pit and do things differently.
Let’s consider a few facts about how significantly a lifetime of car payments affects your financial future.
Car Payments in America Today
That’s hundreds of dollars that could be used to save for college, pay off your house early, or invest for retirement. Instead, most Americans have large portions of their household income going to vehicles.
And many households have two payments of this size, or more!
When you purchase a car, its value immediately drops as soon as you leave the lot. A $30,000 car will lose about 20% of its value very quickly. And it will continue losing value for the rest of its useful life.
Not to mention the ever looming threat of repossession if you fall behind on payments.
The True Cost of Car Payments
What if instead of a $716 payment per month, you put that into a Roth IRA and chose good investments? Even just S&P 500 index funds?
Using a compound interest calculator, with an annual rate of return of about 10%, and a variance of 2%, here’s what your retirement account balance could look like in 40 years.
Back when I originally published this article in early 2019, here is the chart I included. This is with a $523 payment at a 10% rate of return.
If that’s in a Roth IRA, it’s all tax-free as well. What would you do with nearly three million dollars or more of tax-free money when you near retirement? I bet you’d want to do a lot of things!
But alas! The burden of a car payment makes that investment very difficult for many Americans.
Breaking Out of the Cycle
First, buy used cars. There are plenty of vehicles for sale that are reliable, safe, and will last for many years. Just because a car has had a previous owner does not mean it is automatically unsafe.
If you do your homework and sharpen your negotiation skills, you can get a very nice used car for a much smaller price tag than a brand new one. (Check out my guide on how to buy a used car here).
Second, decide to not borrow money for cars in the future. If you currently have a car payment, apply it to your debt snowball, and aggressively pay it off as fast as you can.
Once you have it paid off, drive it for a while. There’s no need to rush into more debt! When you have no debt, you can then take that same car payment and instead invest into assets that will grow your wealth.
By the time you need to replace your car, you can have built up savings to write a check and drive away debt-free.
How Much Car Should You Purchase?
A good rule of thumb is that the total value of all vehicles in your household should not equal more than half of your annual household income. Otherwise, there is a lot of money tied up in things that are losing value.
If you make $50,000 a year, a $30,000 car would be too high. $20,000 would be more reasonable. But I would probably aim for about $15,000. You can still get a nice car in these price ranges.
Want to hear about a way to have a “free” car? If you plan on driving your cars for 7-10 years at a time, you could put what would have been your monthly payment into an investment account. Let that amount grow over that period, and use only the growth portion to pay for your next car.
This would only really work if you plan on keeping your cars around for a while. That will give the market time to adjust from any down periods. But if you create a good-sized nest egg in a solid mutual fund, you could just use the account’s growth to pay for each car you buy in the future.
Final Thoughts on Car Payments
Car payments do not have to be a permanent part of your life. You can choose to take a different path, the path that most American millionaires follow.
Almost none of them have a car payment, maybe minus the first one they had early in their lives. They specifically avoided those payments, and instead saved and invested. That’s how they built lasting wealth.
Book your free Discovery Session today so we can talk about how you can find the financial freedom you are looking for!