The Not-So-Magical Car Formula

If I told you that you could upgrade your car every two years without ever upgrading your car payment, would you believe it? If I told you that you could pay cash for a luxury ride, would you think I was trying to trick you? If I told you that you could drive better and better cars for the rest of your life without ever having to borrow money to do it, would you think I’m crazy?

Well call me crazy. There’s a great way to buy quality used cars, and to upgrade them often, all without taking on large monthly payments. It may seem like magic, but it’s really just a combination of discipline, strategy and some very simple math.

There’s no way of getting around the fact that cars are expensive. With the exception of our homes, cars are the most costly consumer items that most of us will ever buy. But there are ways that we can soften the blow that car purchases make to our finances. New cars are for suckers, and car leases are an expensive illusion. And don’t even get me started on borrowing money to buy cars — that just makes an expensive purchase even more expensive. The only savvy way to drive is to buy used cars with cash.

Now I know what you’re thinking: “Buying a used car with cash sounds great, but where am I ever going to come up with the $10,000 I would need to buy the kind of used car I want?” Well, you’ll get there soon enough. But the answer starts with buying a much cheaper car, and then saving money on a monthly basis so that you can upgrade it later.

All cars depreciate over time, but used cars depreciate much slower than new cars. And the cheaper the used car, the slower its depreciation will be. So here’s the key to this strategy: To buy better used cars, we just have to save money faster than than the value of our current car is dropping.

Here’s how it works. You’re going to start with your current, debt-free car (or scrounge up some cash to buy a cheap car if you don’t have one now). You’re also going to start saving money every month toward your next car. As long as you save more money each year than what your car loses in value, you’re building up the balance of what you can spend on your next car.

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Let’s look at a concrete example. Say you have a car that’s worth $2,000. It may not be a nice ride, but you can probably keep it running for a few more years. Now, let’s say that you can set aside $200 each month to save for your next car. In two years, your current car will be worth about $1,000, but you’ll have nearly $5,000 saved. That means that you can sell your current junker and spend a total of $6,000 on your next car — quite an upgrade!

Now, we’re going to take that system and apply it over and over. You continue to save around $2,500 each year, and you sell your cars every two years. Here’s how it looks as the years go by:

Year 0 — Original car is worth $2,000.

Year 2 — Original car is worth $1,000, and you have $5,000 saved. Result: Buy Car 2 for $6,000.

Year 4 — Car 2 is now worth $4,000, and you have $5,000 saved. Result: Buy Car 3 for $9,000.

Year 6 — Car 3 is now worth $7,000, and you have $5,000 saved. Result: Buy Car 4 for $12,000.

Year 8 — Car 4 is now worth $9,500, and you have $5,000 saved. Result: Buy Car 5 for $14,500.

Year 10 — Car 5 is now worth $12,000, and you have $5,000 saved. Result: Buy Car 6 for $17,000.

So, after 10 years, what do you have? You have a $17,000 car — a very nice used auto! And you paid cash for it!

Under this strategy, your “car payment” is just $200 per month. But remember, that’s not a payment to a bank (with interest) — that’s a payment that you make to yourself. And as your income increases over time, you can add to your monthly car savings if you want, which allows you to buy even better cars. And you don’t necessarily have to upgrade every two years — as long as you’re saving money faster than the car is depreciating, you can hold on to the car for as long as you want before upgrading. The principle will still apply.

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I hope you see that with some discipline, some strategy and simple mathematical principles, you can turn the expense of driving into a very manageable part of your financial life. You won’t start off with a sweet ride, but after a few years, you’ll find yourself paying cash for a great car.

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Photo by Joao Trindad. Used under Creative Commons License.

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  One thought on “The Not-So-Magical Car Formula

  1. Patti
    April 24, 2012 at 10:13 pm

    Love it! I have started saving for a car and this gives me a very practical plan. Thanks!

    • April 25, 2012 at 8:48 am

      Awesome — glad to hear that this was helpful!

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