(This is the second in a series of blog posts on Personal Finance Fallacies. Stay tuned for at least three more posts in the series, released every Wednesday at 9:00 AM MDT.)
For the last 3+ years, I've had the BEST car payment in the world: $0.
That's right! I haven't had a car payment since March 2015.
Yes, I have two cars and no car payments. No, I'm not a millionaire. But without a car payment, I'm on my way to becoming one!
Have you ever been told that you will always have a car payment? That debt is simply "a way of life"?
I used to think that way. I bought my first car in August 2011. I had just gotten a job in the opposite direction from where my wife worked, so I couldn't carpool with her anymore. She had bought her car the year prior, before we were married. The payment on her car was $262. It hadn't even crossed my mind that it was possible to buy a car with cash!
Not that we had the money. We were newlyweds, I was still in school, and she earned a teacher's salary. So I walked up to a car dealership and bought a 9-year-old 2002 Honda Civic for $8,300. The car payment was $172 per month.
So there we were, spending $434 each month on cars. We weren't the only ones; I'm sure lots of people have stories like ours. But it could have been worse! We could have purchased brand new cars, which would have lost half of their values in just a few years.
Or we could have "upgraded" every few years. That's expensive too! Did you know that you pay a bunch more in interest during the first half of a loan term than the last half? So when you upgrade every 2-3 years and get a new loan each time, you are repeating the most expensive part of the loan term each time! Because you pay a bunch to interest, the value of the car decreases faster than the loan balance does, and before you know it, you're underwater.
But it's okay, you can just find a car dealership who is willing to absorb the negative equity into a new car loan when you trade your old car for a new one! (Sarcasm, guys, in case you didn't catch it.) You know, it's really funny when a car dealership does that. They make it seem like they're doing you a favor.
Spoiler alert: they aren't.
First off, you trade in your old car. Do you think you get full market value for it? No! They need to sell it at a profit! You only get a wholesale value for it. That alone costs you a few thousand dollars. (Next time, get more money out of it by selling it to a private individual.)
Second, they sell you a new car, likely a pricier one than your old one. You don't need a new car. Your old one was just fine, but car dealerships (and most people) have turned your car into a status symbol, and yes, you absolutely must promote the image that you're doing well for yourself. (Just pretend that you aren't underwater on your car loan.)
Third, they roll the negative equity from your old loan into your new loan. The car dealership is thrilled to have you pay interest on the larger balance instead of the smaller one. It doesn't matter to them that the loan isn't fully collateralized; they're making so much money on the interest that they don't care!
"Ok, Aaron. We get it. Car payments are bad. But how do we break free from them?"
There are a few things you have to:
1. Accept the fact that used cars are fine! They depreciate much less than new cars, so they are more likely to retain their value better. I know, everyone is terrified of being sold a lemon, but really, most used cars these days are still good cars!
2. It's okay to hold on to your car for longer than 2-3 years. Keep paying on the loan until it's completely paid off. You can't imagine the feeling you get when you know that you own your car, not the bank!
3. Keep paying yourself the loan payment in a savings account for a "car fund." Since you've been paying the loan payment all along, you aren't changing your lifestyle any. But the amounts add up eventually! If your loan payment was $250, you'll save up $3,000 in just one year!
4. After you have been saving for a few years, you can finally upgrade your car, if you want. But this time, you'll be paying CASH. If you had saved for three years, you have $9,000 to go toward a new-to-you (read "used") car! Oh wait! You also get the equity out of your old car! Sell it to a private individual so that you get the full market value out of it. Take the proceeds from the sale and add the $9,000 you saved up. That total should get you a pretty nice used car!
5. Do it all over again! This time you can enjoy a nicer car while saving up over a shorter period of time (since you don't have to pay off a loan this time).
It will take some patience and effort to get out of the "rut" of car payments. But it's definitely worth it! Give it a shot! You will feel better when you know that you own your car instead of your car owning you. I know I do. I drive my 16-year-old Honda Civic like I'm the richest guy on the street, because I know that my car is mine!
(Here's "Uncle Dave" Ramsey again, on the topic of cars and car payments!)
(If the video doesn't work, click this YouTube link to watch it directly on YouTube.)