Congratulations! You just made your last car payment. What a relief!
Suddenly, you have an extra $200 to $600 per month in your budget. What are you going to do with all that extra money?
Here’s my idea: Keep making car payments – to yourself.
Many People Don’t Save for a Car
Many people “don’t know” where that extra $200 to $600 per month goes. They spend it piece by piece.
An extra restaurant dinner ($35), a new pair of shoes ($30), and poof! Before they know it, $200 a month has gone down the drain.
It continues for years until, one day, their car breaks down and the mechanic says it’s not worth fixing. It’s time to buy another car. But they don’t have the cash to make the purchase. What do they do?
They take out yet another car loan. They make a down payment of $1,000 and sign for a five-year loan with payments of $200 or $600 per month.
They spend thousands on interest charges. They spend hundreds more on insurance as they need the most coverage over the life of the loan.
How can you avoid this? Make a car payment to yourself.
Keep Making the Same Car Payment
Should you pay cash for a car? In most cases, yes, especially if your alternative is taking on excess debt, and then spending your cash on discretionary items like restaurant meals and nicer vacations.
Many people would like to buy their car in cash, but they don't have that type of money lying around when it's time to purchase their next vehicle.
But there's a simple solution.
After you finish making your last car payment, pretend you’re not finished. Pretend you’re still making a monthly car payment.
Each month, transfer the money you normally would have spent on a car payment into a separate savings account. You can use this money for your next car purchase.
After You Pay Off Your Car, Pretend You're Not Done
Each month, transfer the money you normally would have spent on a car payment into a separate savings account. Label this "next car purchase."
Set this up as an automatic transfer. Since it's automatic, you won't forget to make the transfer. Have it happen two to three days after you get paid, so you won't miss the money.
Want an example?
Let’s assume your car payment is $200. Once you’re finished with payments, set up an automatic monthly transfer of $200 from your checking account into that separate savings account.
Banks like Wells Fargo and CapitalOne360 allow you to open multiple savings accounts and give each account a “nickname.” Doing this allows you to see what goal each savings account is for.
If you save $200 every month for five years, you’ll have $12,000 – enough to pay cash for your next car.
Figure Out Your Dream Car, Then Work Backwards
Here's another option:
First, figure out what car you want. Next, work backward to decide how much you should save each month.
Let’s say you want to buy a car that costs $20,000. You hope to buy it within three years. Working backward, you'd need to save $555 per month ($20,000 divided by 36 months).
That means you’ll need to save your “normal” car payment of $200 per month (from the above scenario), plus an additional $355.
Is that too much? If so, you’ll need to adjust your goals. Either buy a less expensive car or wait longer than three years before you buy your next car. For example, if you buy a car in four years instead of three, you’ll only need to save $416 per month ($20,000 divided by 48 months).
You could also afford your dream car more quickly by earning more. If you can save $200 per month, and earn an additional $355 per month plus taxes by working a second job, you can set aside $555 per month so you can buy your dream car in three years.
Don’t Ignore the Ongoing Costs
While you’re busy saving for your next car, don’t forget you still need to set aside money to maintain your current car.
For example, you need to pay for car insurance. The bill might arrive once every six months. Don’t forget to set aside money each month to pay it. An insurance bill of $300 every six months means you need to save $50 per month.
You also need to pay for standard maintenance and repairs on your car. You may want to set aside an additional $50 to $100 per month for this.