A Free Car? Not Really…

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Today I found this post on Dave Ramsey’s “Drive Free” plan via The Simple Dollar, even though it’s been around awhile. Now, I’m a good INTJ and love thinking through scenarios. It’s what makes getting out of debt fun for me! I loved seeing the math on this one, as I heard about this plan a year ago and immediately thought there was something fishy about the math, and the simple reality that cars depreciate. Fast.

Put simply, Dave Ramsey’s plan fails on several grounds. First, you should plan on saving upwards of $450 per month for it to work remotely. Second, you’ll be buying some incredibly unreliable cars at the beginning, causing potential need for major repairs, ruining any chance of this working. Third, you won’t be in a new car for 6-7 years or more at the rate of upgrading. Fourth, you have to pay taxes/tag/title every year! Fifth, it doesn’t change the fact you’re putting away $450 a month for the next decade or more. For someone who has a lot of good monetary advice, it surprised me how wrong he is on this point.

This inspired me to figure out my own scenario. As a nuclear engineer, I was/am all too familiar with the concept of decay, and the types of models they present. I’m not so hot on calculating the cost benefit scenarios of owning a house (yet), but knew I could come up with something that takes advantage of the depreciative value of a new car.

First, I had some conditions. I do not want to ever spend more than $300 per month on a vehicle, unless my financial situation has a major shift in the next decade. Second, I don’t want to buy used again. Third, I want to trade in the car at that sweet spot of few repairs and maximum trade in value, or the plateau in the depreciation curve. I calculated about 7-8 years on most cars for that to happen, given more than average driving (150k miles in 7-8 years). Fourth, I don’t demand an incredibly nice car each time, but I do want to progressively get nicer cars. Fifth, I don’t mind using credit to buy, as long as the monthly payments are ok.

I came up with this:

Car Buying Scenario

As you can see, I’m taking each car long-term. If you have to have the flashy newest car all the time, this isn’t going to work for you. But until I can afford my Bentley, I don’t mind driving a sub-$20k car for the next decade. I prefer to get a small economical car and then upgrade the heck out of it. It makes it feel more luxurious, rather than getting the standard package on a nicer model. I also use consumer reports regularly, so my trade-in values are maximized and I don’t get a lemon. The trade-in values I used in the chart may be a bit off, but the plan still works; just slower.

My current car is a 2005 Impala I bought in Jan 06, with 30k miles at the time. I expect it to last me seven years total before repairs start mounting (compare this to a $4k junker that Dave wants you to buy). At that time, I will have about $8,000 to put towards a new car. This means I can now finance a cheaper amount on a much nicer car, which means I can then drop to a 3-4 year note, rather than 5. This means, in turn, I can upgrade sooner, I can maximize the trade-in value, and will have more years of savings the next time I upgrade. Eventually, I will be able to get a $25k car on a 1-year note, still paying just $250 per month. If you follow it to its natural conclusion, I will one day be able to purchase a $30k+ car with cash.

I purposefully do not calculate in the interest gained during the savings periods. That extra money can be used for the taxes/tag/title. I also do not include the tax benefits in claiming depreciation on the new cars, which also saves you a little bit. If you look at the chart, you can see how even bumping it up to $300 per month would either get me a much better car, or allow me to upgrade more quickly each time. I simply pay $250 or so for the next few decades, and I’ll eventually be in a BMW. Or a nice mini-van, depending on my family situation then.

The issue here is whether or not you feel comfortable using credit wisely. Currently my car note is only 4.8% interest, which would make it stupid to pay cash ahead of time, considering I can earn more than that over five years in one of many available savings accounts. When you factor inflation into the equation, it makes the scenario even better to use credit for a car purchase rather than paying cash up-front. In fact, if you get a good rate like I did, it almost makes more sense to finance the whole car for 5 years every time, and keep your money in savings to use for the monthly payments. I have not run the calculations on that, but I imagine you would be able to add $1-2k to each new car given the extra returns, and a lot of dealers will give you a better deal if they know you’re financing for 4-5 years. Also, if you’re willing to stick with a cheaper car all the time, you can decrease your monthly payment gradually, making your car less of a monthly burden.

The best thing is if problems happen, such as an engine replacement or something major (worst case scenario), it doesn’t ruin your whole plan. You use your current savings, and the next upgrade, you simply buy less of a car or even finance slightly longer. Also, the major thing in all this is that you don’t have to start some plan right away! You simply start where you are (likely making payments on a car), make a commitment to save about two years after repayment before buying again, and let the cascade begin. The point here is that if you don’t have to have the newest thing all the time, and are confident with using credit to your advantage, you can come out better in the long run, without making major sacrifices in the beginning.

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