Over at Bible Money Matters, there is a description of Dave Ramsey’s program to “Drive free cars”. Basically, his theory is that if you save enough money in a mutual fund at a 12% return, you can eventually have your cars be completely free. Seems like an interesting concept, but the downside of it for me is that you’ll end up driving a junker for awhile, which could very well mean expensive repairs.
Let’s take a look at how you would end up after 8 years if you purchased a car with a 5-year loan at 0% interest (which is pretty easy to get right now) and then kept making your payments into a savings account, versus Dave’s method. Read more with the link below!
Assumptions:
* Payment of $417/mo in either plan (this would buy a $25k car at 0% interest)
* Keeping saved money in a mutual fund that earns 12%
* No car repairs needed, same maintenance schedule on used car vs. new car (yeah right.)
0% Method:
* Purchase car at 0% interest for 60 months, pay a total of $25,020 over 5 years for the car.
* At the end of the 5-year period, start paying $417/mo into a mutual fund that earns 12% interest. At the end of a 3-year period (for a total of 8 years), you will have paid $15,012 into your mutual fund, and it will be worth $17,964.
* At the end of the 8-year period, you own a car that is worth around $3000, and you have $17,964 in your mutual fund. So you could trade in your car and your cash, and purchase a car for around $20,000 in cash.
Dave’s method:
* Purchase a $1668 car with cash on hand.
* Pay $417/mo for four months to “pay back” your savings for the first car. Total: $1668
* Save $417/mo for 12 months. Total paid is $5004, with interest you have $5324 in your savings account.
* Sell car for $1000 and purchase new car for $6000. You’re now 16 months into the plan, and are driving a paid-for $6000 car, and you have $324 left in your car savings account.
* Save $417/mo for 3 more years, for a total of $15008 paid and $18419 in your savings account.
* Sell your car for $2000, and purchase a $20,000 car. You have $419 left in your savings account.
* You are now 4 years and 4 months into your plan, have paid $21,680 into your savings account, and are driving a $20,000 car.
* Save $417/mo for 4 years, for a total of $20,016 paid into your savings account, and a total of $26,103 in your savings account.
* At the end of the 8-year and 4-month period, you own a car that is worth around $6000, and have $26,103 in your mutual fund. So you could trade in your car and cash, and purchase a car for around $32,000 in cash.
So it does look like Dave’s plan will get you a better car, on paper at least. However, a few things to note:
* Over a loan period this short, it can be very difficult to get a 12% return on your money.
* On the 0% plan, you start with a brand new car. On (my interpretation of) Dave’s plan, you are driving a $1500 beater for the first year, and then a $6000 car for the next 3 years. The nice thing with the new car is that you can often get a warranty that will cover the first 100,000 miles or 5 years, so you don’t run a risk of high repair bills for the period where you are still paying for the car.
Personally, I’d probably stick with the 0% new car plan, as our budget is tight, and it could be tough to keep enough money in savings for repairs if the car breaks down. What would you do?
thanks for the link!
The whole thing about getting a 12% return on my money in such a short time was a bit of a stretch for me too - i’m still waiting for the part of financial peace university where they tell you what investment exactly he thinks you should use to get that kind of a return..
Even if you don’t buy into all his assumptions, his idea of saving up for big purchases is still sound I think. I think we’re going to try this system and see if it works for us.. We’ve had good luck with used cars - I’ve got a 7 year old chevy with no real repair costs yet- and my wife has a 6 year old honda with no repair costs yet. No payments either since they’re both paid off.. So we’re starting his system with our current cars, and saving up for a couple of years..
We’ll see!