It’s no secret that we believe spending too much on a monthly car payment is one of the worst things you can possibly do with your hard earned money. For millions of people this takes the form of leasing a car, buying a new car every few years or just buying an expensive car they can’t really afford. We discussed this topic in our Financial Rules as well as the A Lifetime of Financial Advice in Your Wallet article and we really want to delve into it further here.
Many people lease their cars or “manage their payments” on owned cards so they trade in for a new car every few years. They just take their car equity and roll it into the next car to ensure they continue on with the same monthly payment. They view this as a positive thing, but it just means they are continually making a car payment, month after month, as years roll into decades.
They justify this behavior because the monthly payment is manageable, they’ve always had a car payment, or they simply want a new car for whatever reason (vanity, perceived safety, worry about a breakdown, maintenance, etc.).
I haven’t made a car payment since 2007 and my wife hasn’t made one since 2010, so for us not having a car payment is a way of life. I have a 2003 Honda Civic and Laura has a 2003 Toyota Highlander and we each expect to own these cars another 10 years with no monthly payments.
I could go into all the reasons why I dislike spending money on cars and especially expensive cars (they all get you to the same place, right?), but instead let’s just look at the financial ramifications over a 45-year working lifetime (age 22-67):
On the heels of our The Miracle of Compound Interest article, this calculation shows how much compounding will amplify your savings if you buy a car with a 5-year loan term and keep driving it for 10 years after your loan is paid off (Years 6-15) and then repeat that cycle twice more over a 45-year working lifetime as compared with someone who leases or manages their payments and makes the same car payment every month for the 45-year period.
In this example Person A will buy a car on Day 1, they will make a $300 monthly payment for a 5-year loan term, then the next 10 years they will save that $300 per month that would have otherwise been spent on a car payment. They’ll repeat this cycle twice more so they’ll buy a new car on the first day of Years 16 and 31. They are paying $300 a month for 15 of the 45 years and they have no car payment for the other 30 years.
Person B will pay what most people consider is a fairly modest $300 per month in ‘managed’ car payments throughout the 45-year span.
Assumptions:
- All monthly car payments will be $300 for Person A and B
- The cars held for 15-years will have no residual value
- All savings will be invested in a low cost mutual fund with an anticipated 8% annual return
The big question is: How much will Person A have sitting in their investment account when they are 67 years old just based off money they saved by not making the extra car payments?
You know for sure that Person A will have made 30 years worth of fewer payments. So they’ll at a minimum have $108,000 ($300 x 12 months x 30 years = $108,000) sitting in their investment account while Person B will have absolutely nothing. But let’s look at the magic of compounding at work here in this chart:
Person A ends up with $742,369 as compared with a whopping $0 for Person B! This wealth accumulation was made possible by Person A simply not buying into the hype of “needing” a new car every few years.
So the next time you hear someone say, “Oh, it’s only a few hundred dollars a month for my car payment, I can afford that,” I hope you show them this article so they understand how much it really adds up to over a lifetime!
Other Examples:
The above example assumes a fairly modest $300 per month car payment (about a $17,000 car with a small interest component) for Person B. If Person B spending more than that per month (and we assume Person A saves the additional amount per month) that just further increases the investment account balance Person A will have at year 45.
I decided to run the same numbers assuming Person A sticks with the same modest car with a $300 monthly payment for their three new cars over 45 years and Person B decides to splurge on a lower level BMW 3-series that runs them $600 per month in managed payments. Person A saves $600 per month in the non-payment months and $300 per month during the 15 years he is making payments (the sum of this spending and saving is the amount Person B is spending each month). Person A winds up with over $2.1 million at the end of the 45-year period!
I ran the same theoretical example but had Person B excessively splurging on a $50,000 BMW 5-series that costs them $900 per month in managed payments. Person A winds up with over $3.5 million at the end of this period!
I know people who own these types of cars and they of course claim they can “afford” them, but do you think they have any clue they are costing themselves millions of dollars? How many extra years are they working just to drive around in a “nice” car?
Notes:
We didn’t take maintenance into account here for Person A, and that’s certainly a consideration. Our cars have needed such little maintenance over the first 10 years of ownership that it’s hard for us to estimate a monthly or yearly figure to include in the above calculation, therefore we omitted it. If you feel it’s necessary to include in the above, you can reduce the $742k, but the larger point certainly holds.
This assumes a new car is purchased by Person A each time. We bought Laura’s Highlander used from Carmax for literally 50% of what we were going to pay for a new car of the same make and model. Buying used would clearly raise the investment balance over 45 years as it would cut at least in half the amount paid during the 15 years of car payments, all of which would be saved.
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Brad, fantastic post here. It’s amazing to see how monthly expenses add up. I want to print this off and show it to a few people that I know. Although, they may reject it as false based on the numbers shock!
I would have loved to see you do a cost analysis for a third individual who never makes a payment. Someone who buys a 3-5 year old vehicles after letting the original owner eat all the depreciation. Or you could just use us as the example.
One car, bought for $1700 4 years ago, with no intentions on upgrading…
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I’m glad you enjoyed the post so much! These compound interest posts fascinate me as I just really don’t think people contemplate how much money can accumulate over a 40-60 year investment horizon.
I plugged your scenario into my trusty compound interest calculator and I figured the $1,700 car would last for about 10 years (might be a bit much) and that you’d invest $300 a month every month of the full 45 year period, but pull out $1,700 from your investment pot every 10 years to buy another used car. The total at the end of 45 years comes out to just over $1.3 million!
Show your friends the calculator I linked to and just have them put in $300 per month with a 45 year investment period. They can play around with the return, but I put 8% which I think is reasonable over 45 years. It’s astounding to see the amount of money you have at the end of that period. And that’s for just saving $300 a month! There is simply no excuse not to have well over $1M upon retirement if all you have to do is put away $300/month.
Great stuff Brad. Thanks for plugging in that last bit. You are absolutely right, it’s crazy to insist that it’s too difficult to stash away a nice size retirement account. When I get to that age, a million won’t be worth much, but I follow your sentiment.
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That’s certainly fair that inflation will erode $1M when you’re 67, but that said, what percentage of people your age will have $1M in assets 40+ years from now? 10%? 20%?
Perhaps those who continue to get new cars by trading their old ones in don’t see the numbers the way you presented them. Most of the time, people are not reminded of something however important if they don’t see it. I would like to see how they’d react if they were Person A.
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Yeah, I think you’re right that they either just don’t see it that way or it was never explained to them in this manner. I think most people are saying, “oh, it’s only $300 a month” not “I want this new car so much that I’m willing to throw away nearly a million dollars on it.” At least I hope so!
For all of us who understand, cutting expenses and saving money just makes sense on every level. It reduces the income you need on a yearly basis and the amount of money you need saved before you are financially independent/can retire (basically just 25x-30x your yearly expenses).
And you’re investing profitably instead of throwing money away on cars and gadgets and other stuff that’s essentially worthless.
Brad you’re right as people are “used” to car payments. When I was younger I foolishly bought a BMW which rally cost me $250,000 on a missed investment opportunity.
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Wow, that’s quite an expensive car! I really don’t mean to pick on just cars of course, but it’s symptomatic of how Americans just waste money constantly and yet complain about “not being able to save.” It’s just that they don’t have their priorities straight!
Great post. I feel the same way about cars…it gets you from point A to point B…there really is no need for an expensive car. I definitely think it’s great to drive cars for a long time…15 years is a long time. But if it is still reliable and running well, why not? I drove my last car for 10 years until the costs of maintenance made it not worth keeping and there are some safety features I’d like to have in a newer car. I bought a used Hyundai Sonata for $13K in cash. I’m hoping it can last a good amount of time, but I do have a long commute and put a good amount of miles on it.
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Yeah, 15 years certainly is a long time, and I hope that doesn’t take away from the message contained in the article. I certainly understand that a “long time” to some people might be 10 years for a car, and that’s fine. But it just can’t be 2-4 years. You’ll just keep throwing valuable money away on something that’s essentially a commodity, not some status symbol or reference to your self-worth as so many people view these things.
I have lived a portion of this. I have been in the work force 30 years and have owed 3 cars. This first was a Honda civic (dealer car with 10k on it) that I paid $4800 for in 1983 and drove it for 14 years. I then bought a very used Mazda pickup truck that I had for 3 years for $2200 I then bought a new Jeep Wrangler in 2000 for $21,500 that I have had ever since. I have had to put about $5000 into the wrangler over the last 3 years, but I expect to be driving this for another 5 years or more. I have always preached that car payments along with the increased insurance and registration fee can\will bleed you of cash.
I’m an Engineer and make a very good salary and could have easily bought any car I wanted over the years. I live close to work and spend maybe 15 minutes a day in my car, max 1 hour on the weekends. Folks need to think about how much time you actually spend in your car. I have 2 daughters that have recently graduated college and drive cars with >200k on them that I bought them (used of course). I whipped up a spreadsheet to show the cost\saving with a constant car allowance (as shown here on this website) and the one thing that was missing was the increased maintenance cost of the older car, this need to be spelled out. The calculation I used was a $300\month allowance for 1983 until 2000 and then an increase to $400\month after that. Subtracting the maintenance costs and NOT trying to figure out the insurance and registration fees; I came up with having $471,033.05 based on a return of the S&P 500 index over that time period. So, I think the 700K+ might not be too far off based on 45 years.
Gordey,
Great comment — I really appreciate you stopping by and contributing so positively. I agree that our analysis was somewhat crude in that it didn’t account for maintenance, but I was really trying to prove the point in general and I’m quite glad your real-world calculations prove this concept so accurately. It’s amazing that it adds up to such significant sums just by the simple fact of not driving a new car. The utility of the used car is the same, but you get rich by driving a used one (and saving the difference of course) — amazing…
There are some definite advantages to not having to make car payments, that’s for sure.
Yes, you can definitely get ‘rich’ by just being wise about your car and car payments. Thanks for the comment
I really hated reading this article because you are so right! I am one of those people who always have a car payment
I plan on keeping my current vehicle long after its paid off so hopefully I will stop and invest instead once its paid off. Thanks for the hard lesson learned!
You make a good point about missing out on valuable opportunities by pursuing the “nice car.” When you really calculate the cost of what could be obtained, you get interesting results.
I genuinely found the comparison that was made between person A and person B was really commendable. Because it has suggested with some statistical analysis by the help of which one can easily gather some knowledge regarding the best way to make payment after investing a partial amount on buying a car. Well, in this regard if someone will take my opinion then I will definitely go with person A, because he is making his payment in such a way that even after spending the amount he also can be able to save some amount of money in his savings which is undoubtedly a good sign. Because most of us always choose payment option without doing any calculation which I think may become a burden for them in future. It does not mean one should feel hesitate while going to purchase a car, rather choose the payment option wisely to remain in the safe and comfort zone forever. Thanks for such lovely post.