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How to Make Sure You Never Need a Car Loan

My wife and I have recently bought a new car. It was used but new to us. The best part about the whole deal was that we didn’t have to take out a car loan.

We paid cash.

car loanNow, we are both in our forties and well established financially. So you might think this purchase was a piece of cake. On the contrary, it wasn’t. It took us two years of preparation to be able to buy this vehicle. But it was worth the effort to avoid needing a car loan.

How did we do it? I’ll share that in a minute and show you the steps to take to never need a car loan again. But first, let’s look at the reasons why people feel the need to take out a car loan in the first place.

I Need a Car Loan

Financing a vehicle with a loan is as American as apple pie. It seems everyone does it. Not only that but it’s assumed the car loan is a normal part of life. Just like a cell phone or electric bill, you will always have a car payment, or so people think.

As my wife and I were handing our cashier’s check to the finance department head at the dealership we bought our car at, we asked him how many of their customers financed their purchase. Want to take a wild guess?

75 percent financed their car at the dealership. That figure did not include those who got a car loan through their bank. So the real number was closer to 85 percent. Like I said, most everyone is doing it.

So why do so many people finance their car purchase? I believe the main reasons are:

1. They don’t plan ahead

I mentioned it took us two years of preparation to buy this car. Two years ago we looked into the future and knew we would need another car around this time. So we started planning then.

We saved money each month to put toward the purchase. By the time we started looking we had more than enough saved up.

Most people don’t do this. They wait until it’s too late and then say, “Oh, I need a car now!” Because they didn’t anticipate that new baby, or the breakdown of their current car or the new job or whatever reason, they were unprepared when it came time to buy. They are left with little to no other option than to take out a car loan.

2. They won’t sacrifice enough

Were there other things we could have done with the money we were putting into savings each month? Oh yes, there sure were. And some months it was downright tough to see that much money go into a boring old savings account.

It’s called delayed gratification – putting off today for some satisfaction that comes later. I can’t tell you how positive the vibes were when we handed over our cashier’s check at the dealership. We were smiling from ear to ear.

I’m convinced most people simply can’t put off satisfaction until later. They’d rather have fun in the here and now than live for a future feeling. They won’t sacrifice enough in the moment. Then when the future need comes and they are unprepared, they get stuck and have to make an unwise financial decision.

3. They want more than they need

Wants and needs are clearly different. And, for cars, there are so many variations in trim levels that it’s easy to blur the lines between a want and a need.

Is leather a need? Are power seats a need? Are the heated and cooled seats or the upgraded stereo system that could shake a two block radius a need? I think you’d have a hard time answering “Yes” to any of those questions.

And that is not even getting into the discussion about car brand and how society and our circle of friends or coworkers influences us to get the “right” type of car.

But this is what happens when people go car shopping. They want something they can’t afford and don’t really need. So they take out a car loan to get that car they “can’t do without.”

It doesn’t have to be this way. Anyone can pay cash for a car. You don’t need a car loan if you follow these steps.

How to Never Need Another Car Loan

So how can you make sure that you will never need another car loan? If you follow these steps religiously it will happen. We’ve seen this work for two vehicle purchases now and will follow it for our next one.

Pre-Step: If you have an existing car loan, pay off that debt as soon as possible. Then follow steps 1-7 for your next car purchase.

Step 1: Determine when your next car purchase is likely to take place. You may not be able to pin this down exactly. Just estimate it close enough. Whether it is 6 months or 7 years from now, try coming up with a timeline.

Step 2: If you have a current car, determine how much you might be able to sell it for or trade it in for. There are sites like Edmunds.com or KelleyBlueBook.com that can help you with this. If at all possible, consider a private sale. Dealerships usually won’t give you current market price for a trade in. You will use the amount you calculate here in Step 4.

Step 3: Analyze your monthly budget. You will need to see how much you can save each month towards the car purchase. This may mean cutting back on some other expenses or finding a way to increase your income.

Step 4: Set a price point for the vehicle. After steps 2 and 3, you are ready to set your price point for the vehicle. Make it a range (ex. $7,000 – $10,000) to give yourself some flexibility in case you over or under perform on your savings.

Step 5: Start saving. Once you have your price point and time frame set you can start saving. Do it religiously.

If at all possible, don’t use this money for anything else. Throw any extra money that comes your way into the car savings fund. You will need to develop a system for tracking your savings for this car.

(Note: While we are saving for a new car, we do allow ourselves to use the funds for repairs on the current vehicle we are driving.)

Step 6: Buy the car. Once you’ve saved the targeted amount of money, have the time of your life searching for the right car and flashing a smile as you hand the car salesmen your cash.

Step 7: Repeat…as often as you need or like.

Move Up in Car Quality

The interesting thing about this system is how it allows you to move up in car quality without taking out a car loan. Here is how that works.

Let’s say you are just starting out and can only afford a $2,000 car. Let’s also assume you did take out a loan for this first vehicle because you hadn’t read this incredible post yet. You pay $200 a month on the loan and have the car paid off in 10 months.

The natural tendency once the car is paid off is to move that $200 to something else in the budget. That is a big mistake. Instead, in the system I outlined, you would continue to save $200 a month in your car fund. So in 10 more months you would have saved $2,000 more dollars.

But your current vehicle still has value, right? Let’s assume that after your 20 months with the car it is now worth $1,500. When you sell it, you now have $3,500 in cash ($1,500 current vehicle value plus $2,000 saved) to buy a car worth $3,500.

Once you pay $3,500 cash for the new car, you keep saving your $200 a month. In another 10 months, assuming the car goes down in value a little, you could get into a $5,000 car ($3,000 current vehicle value plus $2,000 saved).

In another 10 months you are looking at buying an approximately $7,000 car ($5,000 current vehicle value plus $2,000 saved).

Theoretically, this process could go on indefinitely, as long as you were willing to keep saving and keep selling your vehicle. But it would work with any savings amount and any length of time needed to save.

The good news is that once you are able to purchase a higher quality vehicle, the length of time that vehicle is reliable stretches out. We plan to hold the vehicle we just purchased for ten years. So for the next five years we will probably not save any money for a car. We have time on our side because of the newness and durability of the car.

But in five years, when half of our ten year time frame is over, we will start the process right back at Step 1.

A Beautiful System

I understand this system doesn’t account for life emergencies. We have other means of handling those. But if you are looking to buy a car without taking out a car loan I’d encourage you to give it a try.

The beauty of this process is that it can work for anyone. The high school graduate looking to buy his or her first car could use this system. So could the single mom who needs a minivan or the CEO looking at his dream car. Anyone can do this. You can absolutely make the car loan a thing of the past.

Questions for Discussion: Have you ever done anything like this? Does taking out a car loan matter to you? What other advice could you give to the system to make it even better?

Image courtesy of Angelo Domini at Flickr Creative Commons

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  1. What type of account do you save you car money in?

  2. Planning for it can make it easy to get a car without a loan. Though I got mine with a loan, I paid down more than half of its price, so the loan wasn’t hard to pay off. Great tips, by the way, Brian.

  3. Great post! I personally plan to follow a similar strategy with one addition: once I get to a reliable car that can last 10+years, I will start putting the car fund money in an investment account dedicated to cars. Once that time horizon goes past 5 years, I think it’s a great idea to look for some growth.

  4. Jayson @ Monster Piggy Bank says

    Congrats! Saving for two years for a car is something hard, but for you it’s not. I think what makes it easy for you is that you completely knew what you wanted and how you did it. Enjoy the new car!

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