Yahoo Finance Can’t Pay Cash for a Car? Follow This Formula To Pump the Brakes on Debt
Buying a car can be costly, but Brian Preston, CFP, CPA and author of “Millionaire Mission,” devised a creative solution to help manage the expense.
“If you can’t pay cash for a car, I recommend following my 20/3/8 car rule,” he said. “You should put 20% down, you should be able to pay it off in three years or less and your car payment should be no more than 8% of your income. This will ensure that you’re getting a reliable vehicle without getting yourself into a financial mess.”
Will this work for everyone? Here’s what the experts had to say.
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What the Experts Say
Angel Costanza, CEO at Beck Bode LLC, a registered investment advisory firm, said that in theory, Preston’s rule sounds great, but it’s not reasonable in today’s economy.
“The median income for Americans is approximately $75,000, and 8% of that is $500 a month,” she said. “That sounds reasonable, right? Where it becomes unreasonable is the three-year part.”
If you pay a $500 monthly payment for three years, that equals only $18,000, Costanza pointed out.
“By using this rule, the average American can only purchase a $23,000 car and that requires a 20% or $4,600 down payment,” she explained. “The average new car sales price according to Kelly Blue Book in January 2024 is approximately $47,000. A new Honda Civic starts at $23,950 which is more than what would be allowed using this calculation.”
On the other hand, Reagan Bonlie, former J.P. Morgan Wealth Management executive and founder of Nudge Money, said he appreciates the simplicity and prudence of Preston’s 20/3/8 car rule.
“The 20/3/8 car rule provides a straightforward framework for responsible car ownership,” he said. “Putting 20% down ensures equity in the vehicle from the start, reducing the risk of negative equity. Limiting the repayment period to three years or less minimizes interest costs and encourages faster debt payoff. Additionally, capping the car payment at 8% of income helps maintain a healthy balance between transportation expenses and overall financial well-being. Overall, adhering to this rule can help individuals avoid excessive debt and financial strain associated with car ownership.”
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Alternatives If You Can’t Afford To Pay Cash for a Car
If Preston’s rule won’t work for you and you need to buy a car, here’s what Costanza and Bonlie suggest.
Costanza said that when it comes to affording the monthly payment, you should take into account all the expenses for the new vehicle.
“Required service, insurance and unexpected bills should be considered,” she said. “Many dealerships now offer prepaid service that can be built into your payment. Spreading out these payments over time and ensuring your car is being serviced properly can save you in the long run and also help with resale value.”
Bonlie said that if you’re unable to adhere to the 20/3/8 rule, you should consider alternative options such as purchasing a reliable used vehicle within your budget, negotiating for a lower purchase price or exploring financing options with lower interest rates and longer repayment terms.
“Additionally, prioritizing saving and budgeting to increase the down payment amount or shorten the repayment period can help align the car purchase with your financial goals,” he said.
Financial Mistakes To Avoid When Buying a Car
“The biggest mistake is not opting for the extended warranty for used cars when the car is out of warranty,” said Costanza. “If you are buying a used car, there is no way to know how well the car was taken care of by the previous owner. If you plan to keep a used car for many years or drive a lot of miles, you should absolutely try to buy a warranty at the dealership. This price is then built into your monthly payment as well. This will save you big time if an unexpected transmission or engine goes.”
According to Bonlie, these are some of the worst financial mistakes when buying a car:
Taking on a loan with a high interest rate, leading to excessive interest costs over the loan term.
Stretching the repayment period too long, resulting in negative equity and potential financial strain.
Purchasing a vehicle beyond one’s means, leading to unmanageable monthly payments and potential financial hardship.
Failing to consider additional costs such as insurance, maintenance and taxes, which can significantly impact the total cost of ownership.
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This article originally appeared on GOBankingRates.com: Can’t Pay Cash for a Car? Follow This Formula To Pump the Brakes on Debt
