While taking part in Dave Ramsey’s “Financial Peace University”, we heard a great example of how you could turn traditional thinking around, and make your money work for you.
Drive Free Cars For Life!
They started the lesson out by talking about how the average new car payment for 1/3 of car buyers is $475 with a loan term of 6 years (for a $26,000 car with 9.6% interest). Most people will just assume that they will always have a car payment, and that having a car loan and payment is just a part of life. It’s something that you can never get away from!
According to Dave Ramsey, if you turn that thinking around, within that first six years you can get to the point where you’ll never have a car payment again!
How To Never Have A Car Payment Again
Let’s say the car you’re driving now is worth $1500, and instead of paying a dealer $475/month for a new car like most people do, you save that money for 10 months. At the end of 10 months you’ll have $4750, along with another $1500 from the sale of your old car. With that money you can buy a new car worth $6250.
If you keep going along those lines for another 10 months, you’ll have another $4750. At the same time you’ll probably be able to sell your new $6250 car for just about what you paid for it. That means you’ll have $11,000 to spend on another new car, just 20 months after you started with a $1500 car!
Let’s say you decide to keep that new $11,000 car for the full six years it would have taken to pay off a new car with a loan. Continue paying yourself that $475 payment every month for the remaining 52 months, and put it into a good mutual fund. If you receive a return of 12%, then you’ll be sitting on over $32,000 dollars after the 6 years is up. Even if you receive a smaller return than that (likely in this environment), you’ll still have quite a bit more saved up than when you started – and no car payments!
Free Cars For Life: Wash Rinse Repeat
If you go now and buy a nice used car for $12,000, you’ll still have 20 grand sitting in your “car replacement fund”. If that fund continues gaining 12%, even if you never add more money to the fund, you’ll be able to buy $14,000-18,000 cars every 5 years from now on! The interest you’re gaining in that account will pay for your new cars for the rest of your life!
How do I retire rich?
Here’s the fun part. Once you’ve established your car replacement fund, from then on you’ll be ok to take that $475 you would have used to pay for your new car loan, and invest it in a mutual fund. If you gain 12% interest, here’s how the numbers work out if you invest that amount for 10, 20, 30 and even 40 years:
- 10 years – $100,000
- 20 years – $470,000
- 30 years – $1,600,000
- 40 years – $5,588,385
So there you go, Dave Ramsey’s plan to drive free cars and retire rich.
While it does depend upon you earning a good amount of interest through your mutual fund (and make some assumptions about a pretty high rate of interest), as well as some other assumptions about car values, it doesn’t sound impossible to me. I know we would never pay $475/month for a car, but at the same time this example really brings home the idea that the returns of compounding interest are something we all need to strive towards gaining.
Let me know what you think about this plan in the comments!
This article makes absolutely no sense. HOW is it driving free cars if you’re paying $475 a month for them??!! This article is simply telling people to save money. Gee, thanks- DUH!!!
You actually expected to drive free cars and get rich with no work? :) sorry, there’s no free lunch! Still, this plan makes a whole lot more sense than what people normally do..
Actually, the program is telling you to buy an investment that then pays for the car. After the 6yrs, you stop putting $475 in the mutual fund. You do something else with the money. I’m surprised the author didn’t reiterate that point. I mean that’s the entire point of the program.
It becomes “free” when the money your money makes pays for the cars
Hahaha, who’s making 12% return on a mutual fund these days!!! I would like to find one that breaks even.
I like the idea but it’s a bit outdated. Compounding is no longer much of a possibility and driving a $6250 car for two years doesn’t sound too appealing. Plenty of potential for unreliability, maintenance costs, etc.
Buying new is still a scam, but working a deal on something off lease with low mileage is appealing, but forget about that being under $10k. Most $6250 cars these days will have well over 100k miles so you get exactly what you pay for.
I have faith that the market will rebound at some point.. Maybe not right away, but it will.
I just bought a 2 year old car with less than 30,000 miles on it for less than $10,000 – on a nice mid-sized sedan. It can be done! Even if a car does have maintenance costs though, it’ll still be less than buying a new car.
Just saw this linked from your tweet.
Ignore the 12% for a moment. Ignore that inflation will continue to increase the car prices.
A particular car I have in mind, Toyota Avalon, $32K new 2-1/2 yrs ago. Blue book is now $15,000 with 35K mi on the car. As a numbers guy, I imagine, and may very well create the graph, a curve that shows the value at 0 mi, the every 5K after. Half the value gone in 2-1/2 yrs, but the car is barely 20% used up, these cars are known to go 200K miles with little repair. Say at 70K miles, it drops by half again, worth $8000. The first 35K miles cost $17K, but the next 35K cost $7K. Readers shouldn’t let the other little details throw them off of the real value in Dave’s concept.
Joe
JoeTaxpayers last blog post..Barack Obama in Cairo
i thought i was thinking on my toes on my way to buy a used car and now, and now u have me thinking really have me thinkinig i think god for your information it was on time, and well thought out iam n love w this idea. Iam now thinking iam going to sevice my van and start a savings plan. Thank you!!
Well, the only flaw in this idea is putting the money that is needed in 5 years or less in a mutual fund. We made the mistake of putting our car fund there, and although I contacted my financial adviser back in 2007 to ask the procedure to remove the money (sidenote – avoid those full service brokers like the plague), he ignored our emails and we didn’t get the money out before the market started tanking. It’s still sitting there, waiting for the recovery.
Fortunately, we keep a good-size cash reserve, and when we decided to let our college student take my old car with him, I was able to replace it from savings.
Annie G´s last blog ..Recipe: Stuffed Grape Leaves (Crockpot)
The last few cars we’ve purchased have been good used cars, which eliminates the huge loss in value within the first couple years. We have also been without car loans for over 10 years. We put the equivalent of a car payment aside in a mutual fund. So, at least we’re getting interest on the money and not paying interest on a loan. Although our cars aren’t “free”, we’re able to drive decent cars at a reasonable cost.
I do not agree with everything Dave Ramsey recommends, but as a graduate of Crown Financial Ministries, I can certainly relate to much of it. As for vehicles, most depreciate rapaidly the first 3 years. We put God first in our business.
great concept, but I’ve always had a problem with Dave Ramsey’s 12% mutual fund return, as if it is a God given right. Let’s see, the Dow crossed 10,000 for the first time in 1999, here we are in 2009 and it is still at 10,000. Assuming one didn’t panic and sell when the Dow went from 14,000 in October of 2007, to 6500 in March of 2009, most people are fortunate to have broken even the last 10 years. There are some strategies that have done well over the last ten years–7-8% maybe, but nothing I know of that made 12%. when will Dave Ramsey start revising his projections to a more realistic return so that people won’t set up false expecations of what their savings will grow to over time? Let’s remember that the average investor doesn’t buy and hold very well–in fact most probably employ a “follow the heard mentality” and buy high and sell low…the same people who bought tech stocks in 1999, oil in 2007, and probably gold right now, etc.
I think the key takeaway from Dave’ advice is not to get so hung up on the “12%” per year, but to look at what he is saying about buying a new $30K car every 5-6 years. I will not use any brand names but if you can find a good reliable sedan as rated by any of the consumer mags that is 2-3 years old with 20-30K mileage you are looking at paying around $15-18K for it. If you can take care of it for 4-5 years you can save the $300-500/month you were paying in car payments and save that money for repairs and basic maintenance you should save $4000-6000/per year. After 3-4 years you have enough money to trade your car in plus the saved money to get another car in that range.
The other key thing is that if you buy a car when you have the money saved up and can take your time you will less likely to make an emotional decision that is not financially sound. If you buy a car when you want to and not when you have to you can walk away from bad deals – you will also notice that you will get a better deal in the long run because you have the power to walk. It is very much like a single person that gives off a scent and cannot get a date, but as soon as you start dating someone or you are married you don’t try too hard and offers seem to come in. Same situation with buying a car – they know when they have you and can dictate price and when they have to meet your demands.
Dave’s views on finances in general is spot on, and I this is a perfect case in point. Car ownership shouldn’t be the reason people stay poor. Great idea!
I like the idea. I am going to try it out. The $475/mo. And a 12% mutual fund might not be my actual numbers that I work with; but I think this idea can work for me and my daughter. Thanks folks!
Dave’s plan hinges on finding a reliable car for that first $5k purchase. When he wrote that ten or fifteen years ago, $5k would buy a ten year old Accord or Camry with just over 100k miles. Now that same ten year old car is more like $8k or $10k. I just went through the process and what I found for $5k was a lot of junk, though it was possible to find the needle in a haystack if you looked long and hard enough.
A year and a half ago I thought I’d found the needle in the haystack, a 2000 Lexus RX300 with 155k miles with perfect body and interior for $4000. But after 15 months it blew a head gasket – a $2300 repair. When I add up the initial purchase price and cost of repairs and then deduct what I got for trade-in, it cost me nearly $300 a month to drive an old (but very nice) clunker for just over a year.
After a month of looking at under $5k clunkers, I came to the conclusion that for that amount I was just going to get another clunker. so I put my available cash and trade in as down payment on a four year old Subaru Outback with 35k miles. I decided long ago that if I am going to borrow money to buy a car I want to get something I can pay off before it hits 100k miles and gets into the higher maintenance portion of it’s life. The payment on this one is about the same as it cost me in the end to drive a car that was 13 years older with 120k more miles. I figure if I’m spending that much anyway I might as well have the safety and reliability of a newer car.
Bottom line = Cash is King. However, sometimes safety and reliability become a higher priority than staying out of debt.
I took the plunge and started auto-saving in mutual fund for Driving Debt Free cars. I would warn people to have their fully funded emergency funds in place before they take the plunge. And I have to be realistic, my current beater (17 year old) which is worth about $2K may need work in the future but I like not having a car payment. I just wish I had started sooner.
I agree with Pastor Karl. I recognize that buying cars used is the way to go, but this argument as a whole doesn’t work for me.
1) The $1500 car is unreliable and going to cost money in repairs, guaranteed.
2) The $1500 car is not going to still be worth $1500 in 10 months when you go to sell.
3) Every time you “flip” a car, you lose money, so counting on doing this several times in a row is a recipe for serious irritation. (I’ve tried this; I know. I bought a super-cute convertible–CASH!–because it was the best value car I could find when I bought it. The independent person I bought it from thought it was really undervalued when he bought it at auction and thought we’d be able to drive it for a few years and sell it for what we paid for it. In three years, when I had a baby and needed a larger car, I think we got 1/2 or 2/3 what we paid for it. I then bought a $3000 Volvo … which after a few years with numerous repairs, is broken down in my driveway and I can barely sell it for parts.)
We pay just about $15/month in interest for our truck, a very nice truck that we got at about 4 years old for about $20,000 less than buying it new. We pay less in interest than we should make in investments, even in this economy (1.9%). Emotionally, it would be nice to pay it off, but financially, it makes more sense to hold on to the loan (In the event of a job loss, I could better afford my small monthly car payment than to have spent out my emergency fund on paying off the car, just to say it was paid off.)
I only ever bought a new car once on my life and it will be the last. As stated the depreciation of the car and the interest on the loan(negative money) cost so much over time. I have 2 vehicles with over 250k and my one (Ford) has 330k on it. Both care were used with less than $8000.00 for both of them. Maintenance cost are no more or less than my new car was. The money I have saved goes into my 401K and it has tripled over the last 8 years and keeps growing. Plus my insurance is less costly without loans.