Sometimes, people trying to save money can be penny wise and pound foolish. They’ll clip coupons to save a quarter on toothpaste, but think nothing of paying hundreds of dollars a year in unnecessary banking fees.
While knowing how to save money on small purchases can certainly be part of living a frugal lifestyle, you’d have to clip a lot of coupons to save enough for something like a car.
So for larger personal finance goals, you need to understand how to spend wisely in the “big three” core areas of your budget: housing, education, and transportation.
In this article, I’m going to focus on transportation and show you how you can save for your next car faster than you thought was possible.
Determining How Much to Save for a Car
Your first consideration when thinking about saving for a car is how much to set aside, and there’s one very important rule to remember at this stage of the process:
The amount of money you spend on a new vehicle should not be determined by the size of the loan you can qualify for.
All lenders have an acceptable default rate. That means that even if X% of borrowers stop making payments, the lender will still make money.
But as a consumer, your acceptable default rate should be 0%. You don’t have the luxury of writing off or absorbing losses — defaulting on a car loan because you bought more than you can afford will devastate your credit score and cause years of ongoing financial problems.
How Much Should You Spend on a Car?
If you read enough personal finance articles, you’ll notice a theme: rules of thumb.
It seems that for any given question, there are no definitive answers that provide specific numbers — just rules of thumb to help guide you to the right answer for your particular financial situation. This can be frustrating, but it’s necessary; not only are your personal circumstances unique, so are your values and financial goals.
When it comes to determining how much money you should spend on a car, there are three rules of thumb you can adhere to. You can plug your own numbers into each of these to come up with a customized answer.
The 10% Rule: Total transportation costs (monthly car payment, car insurance, gas and regular maintenance such as oil changes) should be less than 10% of your take-home pay.
Ramsey’s Rule: Dave Ramsey recommends that the total value of all your vehicles should not exceed half your annual income. Like much of Ramsey’s advice, this is more tailored and applicable to low-income households than medium-income or high-income households.
50/30/20 Rule: This is an overall budgeting rule. 50% of your income goes to essentials, 30% to discretionary spending, and 20% to saving/investing. Using this rule, transportation costs need to fit into the 50%.
Here’s an example that works for all three.
If your take-home income is $5,000 per month:
- The max you can spend on all transportation costs should be under $500 per month.
- Your car should cost under $30,000.
- You have $2,500 to spend on essentials, so your transportation expenses are competing with things like housing, food and utilities. In general, housing should comprise no more than 30%, so that leaves $500 per month for all other essential expenses — including transportation.
Paying in Cash vs. Saving for a Down Payment
I know that debt is often considered a dirty word in the personal finance world, but not all debt is bad — and that includes auto loan debt.
A credit score above 760 will get you the lowest interest rate on your loan. If you have a score of 760 or higher, making a down payment and borrowing the rest of the money shouldn’t necessarily be viewed as a personal finance mistake.
But if your score isn’t quite there yet and you’re in no big hurry to buy a car, there are plenty of ways to boost your credit score so that when the time comes, you get a good interest rate.
If you are going to finance a car, here’s another handy rule of thumb: 20/4/10.
- Make a down payment of at least 20%.
- The length of the loan should be four years or less (to limit the total interest you’ll pay).
- Total monthly transportation expenses should not exceed 10% of your net income.
That said, I personally prefer to pay cash because it keeps me honest as far as how much car I can afford. If a car is outside my budget, but I’m making a monthly payment… hey, $30 extra dollars a month doesn’t seem like that big of a deal.
But over the course of a four-year loan, that extra $30 a month is $1,440 above my budget! Not to mention, since my budget has to include the interest I’ll be paying on the loan (not just the cost of the car), I’m going to end up getting less car for my money.
Where to Save for a Car
It’s important to not only know how to save for a car, but also where to save for one. Buying a car is a short-term goal — something you plan to do in five years or less — so this money should not be invested in anything with a lot of risk or volatility. Five years simply isn’t enough time for that money to ride out the regular ups and downs of the stock market.
But if you leave that money in your checking account, you might be tempted to spend it. And if you keep it in your savings account, it’s earning almost zero interest. So in this case, no rule of thumb is necessary — the specific answer is a high-yield savings account.
Using a High-Yield Savings Account and Automated Withdrawals
When searching for a high-yield savings account, you’ll find that online banks often have better rates than their brick-and-mortar counterparts. You can start your search below:
Since you utilized one of the rules of thumb discussed earlier, you know your budget. Next, you need to decide your timeline. How many months from now do you plan to buy a car? Divide these two numbers, and this is your monthly saving goal.
For example, say your goal is to buy a $30,000 car in 12 months. In that case, you’d want to save a minimum of 20% for the down payment, which is $6,000. From here, divide $6,000 by 12 to get the amount you’ll need to save per month, which for this example is $500.
Any financial goal — from saving for a car to planning for retirement — needs to have a timeline. Without one, you have no way to evaluate whether you’re on the right track or whether you need to change course.
Next, look at your overall monthly budget. Is the amount you need each month already in your budget, or do you have to find it? If the latter is true, the good news is that there are many ways to decrease expenses and increase income.
Once you have that extra money in your checking account, you want to move it to your high-yield savings account immediately to maximize your interest earnings.
You can do this yourself, but meeting your financial goals requires absolute consistency. And unfortunately, life often gets in the way of our best intentions. So if you’re not sure you’ll be able to stick with this process, there are a couple of automation tools that can help you.
Boost #1: Round Up Your Purchases with Acorns
Acorns is an automated investing app. Link your debit or credit card to your Acorns account, and each time you make a purchase with the card, the amount will be rounded up to the nearest $0.25, $0.50, or $1 (you set the amount). After reaching $5, the money will be automatically added to your investment portfolio.
While it’s true that I said earlier in this article that funds for your short-term savings goal should not be invested, Acorns allows you to choose what to invest in and one option is a “conservative” portfolio, which holds 80% bonds — an asset allocation that should prevent any big swings in value.
There’s no cost or minimum to withdraw funds from your Acorns account, so if you do get a good chunk of money in your account and your deadline is approaching, I’d suggest withdrawing that money into your high-interest savings account sooner rather than later.
Boost #2: Transfer Money Effortlessly from Checking to Savings
Digit is an app that automates your savings. It uses an algorithm to analyze your income, expenses and spending habits, and then determines how much of the money in your checking account could be safely set aside. A few times per week, that amount is automatically transferred to your Digit savings account.
Digit has a number of great features, such as the ability to define specific savings goals and timelines.
Getting Maximum Value for Your Current Car
When you’re thinking about saving for a new car purchase, selling it sometime down the road is probably the last thing you’re thinking about. But that day will come, and when it does you’ll want to get the best price possible for your asset.
Hopefully, that day is far in the future. People who spend wisely on cars own them for a long time. Your goal shouldn’t be to pay off your car and then immediately buy a new one; rather, it should be to save money on transportation, which is such a key part of your budget. If you do, you’ll have more money left over for investing (or other things that are important to you).
So make sure to budget for regular maintenance. You’ll get maximum value by selling privately (as opposed to selling to a car dealership), and buyers will pay a premium for a used car if you can show records proving that the vehicle has been properly cared for. But if you fail to include maintenance in your budget, chances are that non-emergency repairs are one of the first things you’ll skip when you want to spend money on something else — following the maintenance schedule suggested in the car’s manual just doesn’t seem very pressing when your car is running perfectly fine.
If you don’t have time to deal with selling your old car (phone inquiries, taking people on test drives, etc.), try going in-house. Let people like family, friends and colleagues know that you’re selling your car.
If there are no takers within your network, be sure to perform your due diligence before accepting a trade-in offer, which can vary by thousands of dollars from dealer to dealer. You should shop around just as much when trading in your car as when buying it.
How To Save For A Car: Summary
If there’s one thing to take from this article it’s that when you keep your home, car and education expenses in line, you give yourself so much more control over your finances. So do your homework, follow the rules of thumb, and you’ll make a decision you won’t regret.