Just the other day a friend of mine told me a story about paying off her car loan. She was in her office and was telling a coworker how excited she was to have just paid it off. Her coworker's response was enthusiastic but came with the immediate question, "So what car are you going to get now?" My friend was confused. She wasn't going to get a new car. She just paid off her current one and was happy to not have any more payments! Once I heard this story, it occured to me just how comfortable we americans have become with our debt and payments. It's typical to buy a new car immediately after paying off or often times before even paying off the current loan. It's unfortunate that we've become accustom to that because that kind of mentality can literally cost you millions of the course of your lifetime - and for what? Is it worth it to always have a new car that you won't care about in a few years anyway? Imagine if I could offer you an amount between $600k and 2.6 million dollars cash at the age of 62 if you could only buy cars under $12k until then. Would you do it? Here's how to make it a reality.

Average New Car Costs and Comparisons

The average new vehicle cost in 2008 was $28715. Most articles would compare that with a $9k car just to get huge figures but I don't think that's realistic and I like to be very conservative with my figures so what I'll be comparing is a $20k car (far under the national average) and a $12k car (very cheap but not the very cheapest.) The fact of the matter is that this will scale up if you'd like to think of it as a $28k car vs a $20k car. I just wanted realistic payments and timeframes to compare with because I do believe most people can swing $400 payments per month but not too much over that.

So 5 year loan on a $20k car is $424 per month with a 10% interest rate. The actual amount you would pay is 25440 because of interest. This means that $5,440 or 27% of the car's total new value is paid in interest. After average depreciation at 5 years, your car is now only worth 8,039.

If instead you bought a car for $12k and paid it in 3 years, not only would you only be paying $387 per month with the same 10% interest rate but your total payments would be $13,932 which is only $1,932, or 16% of the car's total new value. After average depreciation at 3 years, your car is now worth $6,676. To make a fair chronological comparison though, after 5 years it will be worth $4,824.

If you then took the payment difference for those 5 years, which would be 37 dollars per month for the first 36 months and then $424 per month for the next 24 months, you would have $1,332 + $10,176 = $11,508 in your pocket.

Investing the difference

If each month you took that money and invested it into just a good money market account at 5% interest, instead of $11,508, you will have $12,572.26. This extra grand didn't even take any skill to get. You just need a basic MMA. If you're a good investor, you'll be able to put the money somewhere where it can get 7-12%, and the amount will be much higher. My guess though is that if you're a good investor, you know all of these numbers and probably don't need to be reading this article.

So, at the end of 5 years, what do we end up with? With the exact same amount of money spent, you can:

1) Buy a $20k car. You will actually pay $25,440 for it. It will be worth $8,039. You will have $0 in the bank.
2) Buy a $12k car. You will actually pay $13,932 for it. It will be worth $4,824. You will have $12,572 in the bank.

What a dramatic difference! Not only is your much more expensive car only worth $3,200 more than the cheaper one, but you will have absolutely nothing else to show for it at that point! The cool part is that if you really, really want to buy a new car then, you could actually buy it cash with the money you saved from the first car. At that point, you have a brand new car with no car payments whatsoever! I still don't believe it's time to buy a new car though. With average maintenance, a new car can last 10 years. Let's keep playing and assume you're willing to hang on to each car until it's 10 years old.

At 10 years of age, your $20k car will be worth $3567. The 12k car will be worth $2,140. This will make the new car purchase a little cheaper, but mostly you'll be using that trade-in just to cover taxes and fees. So what are you left with after 10 years? Not a whole lot. Cars aren't really worth much. They cost a lot and can be fun to have for a while, but they always get old and they always lose value. That's a fact of life. This rule implies that the more expensive your car is, the more money you will lose. The difference between the 20k and 12k car after 10 years is only $1,400 - which may translate to around $700 on trade-in value. That's virtually nothing compared to how much more the $20k car cost to buy.

Enough with that though - let's see how this works out if you do this your entire life:

Let's say you buy your first car at the age of 22, right out of college. You got your shiny new $45k/year job and are ready to get an apartment and a new set of wheels. Every 5 years you finish paying off your last car and trade it in for a new one. You continue this for 40 years, until you're 62. Here's what it costs you:

$424 x 12 x 40 = You spend $203,520 to have a new $20k car every 5 years until you're 62.

Let's run the same scenario (22, fresh out of college, etc) but buy a $12k car every 10 years and when not making car payments, put the money into a MMA (Money Market Account). Here's how it breaks down:

$387 x 12 x 12 = You spend $55,728 to have a new $12k car every 10 years until you're 62.
($37 x 12 x 12) + (424 x 12 x 28) = You save $147,792 which if put into your MMA every month over those 40 years would make you a grand total of: $437,620.84

Just for fun I ran 2 more interest rates. 7% which is a stable mutual fund and then 12% which is at the high end of possible returns and requires a long term and somewhat volatile portfolio. At 7%, you would have $716,189 and at 12% you'd have a staggering 2.6 million dollars. This makes many assumptions about the market but the fact of the matter is that if you can just scale back what kind of car you want and learn to live with it for 10 years instead of 5, you could easily add another half to two-and-a-half million to your net worth by the age of 62.

What kind of car could you buy then?

References and Sources:

Interest Calculated at 5%:

yr 0) 444 invested for 3 years = 1,469.70
yr 3) 5088 invested for 7 years = 45,565.88
yr 10) 444 invested for 3 years = 54,217.90
yr 13) 5088 invested for 7 years = 119,787.90
yr 20) 444 invested for 3 years = 140,139.16
yr 23) 5088 invested for 7 years = 240,687.74
yr 30) 444 invested for 3 years = 280,095.84
yr 33) 5088 invested for 7 years = 437,620.84

Interest Calculated at 7%:

yr 0) 444 invested for 3 years = 1,527.33
yr 3) 5088 invested for 7 years = 49,566.43
yr 10) 444 invested for 3 years = 62,248.34
yr 13) 5088 invested for 7 years = 147,071.11
yr 20) 444 invested for 3 years = 181,695.77
yr 23) 5088 invested for 7 years = 338,877.58
yr 30) 444 invested for 3 years = 416,666.94
yr 33) 5088 invested for 7 years = 716,189.93

Interest Calculated at 12%:

yr 0) 444 invested for 3 years = 1,678.02
yr 3) 5088 invested for 7 years = 61,202.41
yr 10) 444 invested for 3 years = 87,663.00
yr 13) 5088 invested for 7 years = 251,287.80
yr 20) 444 invested for 3 years = 354,719.29
yr 23) 5088 invested for 7 years = 841,664.18
yr 30) 444 invested for 3 years = 1,184,155.59
yr 33) 5088 invested for 7 years = 2,675,283.58

Auto loan payment calculator used:
http://www.bankrate.com/brm/auto-loan-calculator.asp
Car depreciation calculator used:
http://www.money-zine.com/Calculators/Auto-Loan-Calculators/Car-Deprecia...
Compound interest calculator used:
http://www.moneychimp.com/calculator/compound_interest_calculator.htm