The Paid-Off Car Is a Raise, the Arithmetic of Driving Your Car Longer

Nobody ever got a raise by shopping for a new car. You got a new car, a new smell and a new payment. The raise was somewhere else, a few years later, on the day you sent the last check to the finance company and then, if you were disciplined, simply did not buy another one.

Let me make a claim that sounds too simple to be true: for a great many families, the easiest raise they will ever receive is the day the car is paid off. No negotiation with the boss. No new job. No tax bill on the extra money, because it is money you stop spending, not money you earn. The raise is hundreds of dollars a month, and it arrives automatically if you do one thing, which is nothing.

I am going to prove it with arithmetic. All the figures below are labeled hypotheticals, chosen to be round enough to follow, and they are illustrations, not predictions. Your car, your rate, your repair bills and your investments will differ, so run your own numbers. The method is the point.

The setup: one car, one loan

Picture a family with a $35,000 vehicle, bought new, financed for 60 months at 7 percent. These numbers are invented for the example. On those terms:

• The monthly payment is about $693.04.
• Over the 60 months you pay about $41,582.52 in total.
• That means about $6,582.52 of the total is interest. You paid it for the privilege of having the car now rather than later.
• The payments add up to about $8,316 a year ($693.04 times 12).

Keep those numbers in front of you. Everything else is built on them.

Premise one: a new car loses value fast

Every driver has felt this, and nobody likes to say it out loud. A new vehicle loses a significant share of its value in the first few years. The exact figures vary by model and by market, so I will use a simple labeled assumption, and you can substitute your own: the car loses 20 percent of its value in the first year, and 10 percent of its remaining value in each year after that.

On that assumption, the $35,000 car is worth about:

After five years, the car has lost about $16,629 in value ($35,000 minus $18,371). In other words, in the years the family was paying $8,316 a year, the thing they were buying lost an average of roughly $3,300 a year in value. The loss is steepest at the beginning. That is why the early years of a new car are the most expensive years of its life.

Now notice what that implies for the person who keeps the car. Most of the steep depreciation has already happened by the time the loan ends. A five-year-old car that still starts every morning has already paid its biggest bill. The marginal cost of driving it a sixth, seventh and eighth year is far lower than the cost of the first five. A new car resets the clock and takes you back to the steep part of the curve.

Premise two: the loan is the biggest line

Go back to the interest. On the illustrative loan, the family paid about $6,582.52 in interest over five years. If the family trades the car after five years and rolls into another loan of similar size, it pays interest again. The cycle is simple: every cycle begins with a new loan, and every new loan carries a fresh round of interest and a fresh round of depreciation.

Compare two families who each need transportation for the same fifteen years, using the same labeled assumptions. The first buys a new $35,000 car every five years on a similar loan. The second buys one and drives it for fifteen. I will not pretend to compute the second family's repair costs exactly, because nobody can, but I can show the shape. Over fifteen years, the first family makes three rounds of payments of about $41,582 each, or about $124,748 (three times $41,582.52, rounded). The second makes one round of about $41,582 and then ten years with no car payment at all. The difference, about $83,165 on these illustrative figures, is paid for a newer car. Whether a newer car is worth that is a fair question, but it is a question the family should answer on purpose, not by default.

Premise three: repairs versus payments

The honest objection to driving an older car is repairs. A car that is eight years old will need things: tires, brakes, a battery, a belt, sometimes something large. Nobody should pretend otherwise, and a family that keeps cars must budget for it. But look at the proportions.

Suppose, as a labeled assumption, that a well-kept car in years six through ten costs $1,500 a year in repairs and upkeep beyond routine oil changes. That is $125 a month. The payment on the new car was $693.04 a month. On those figures, a full year of repairs ($1,500) costs a bit more than two months of the old payment ($1,386.08). Even if repairs were double my assumption, at $3,000 a year, they would still be well under half the annual cost of the payments ($3,000 against $8,316).

The comparison also hides a risk on the other side. A major repair can arrive in one chunk, and a family with no cushion can be knocked off balance by it. That is why the plan below includes a repair fund, and why this column keeps linking back to the emergency fund idea; see Why the Emergency Fund Comes Before Every Other Money Goal You Have.

One more thing the sticker never shows. Insurance premiums, and in some states registration fees, often track the value of the car, and a family can often review the coverage on an older vehicle and ask the insurer, not an ad, what the right level is for a car worth less than it used to be. Nobody should drop protection they need, and I am not giving insurance advice; the point is only that the cost of ownership has more lines than the payment, and several of them shrink as the car ages. Ask each year what each line costs, and write the answer on the same page as the plan.

Premise four: pay yourself the car payment

Now the part that turns a saved payment into a raise. When the loan is paid off, the $693.04 a month does not have to vanish into the general stream of spending. The old payment is a habit, and the family has already proved it can live without that money. So keep the habit, and send the money to yourself.

Here is a labeled plan. Out of the old $693.04 payment, keep $500 a month as savings and set aside the remaining $193.04 a month, which is about $2,316 a year, as a car repair and upkeep fund. That fund covers the $1,500 a year I assumed above, with room to spare.

What does the $500 a month become? Assume, as an illustration and not a promise, a 5 percent annual return, compounded monthly, for ten years. The savings grow to about $77,641. You put in $60,000 ($500 times 120 months), so about $17,641 is growth. Past returns do not guarantee future ones, and an actual investment can do better or worse, but the principle is plain: a family that keeps a car ten years after the loan ends and saves the payment has turned a depreciating asset into a growing one.

Put it in terms of raises. A family that sees $500 a month appear in savings, with no added work, has received the equivalent of a raise of $6,000 a year before taxes, and it is a raise that compounds. A worker would need a substantial salary increase to bring home the same $6,000 after taxes. The paid-off car does it with a screwdriver and an oil change. To see what compounding does over time, work through Compound Interest Year by Year, the Arithmetic That Rewards the Patient Saver.

The objection, stated fairly

The best case against all this goes as follows. A new car is more reliable. It has the latest safety features. It is under warranty. It will not strand you on the highway, and your time and peace of mind have value. An old car is a gamble, and the family that depends on one to get to two jobs cannot afford to gamble.

Some of that is right, and I will not wave it away. Newer cars do carry modern safety technology. A warranty is a real benefit. And a breakdown costs a worker more than the repair if it makes him late to a job where lateness is punished. The man who says every old car is a bargain has never been stranded on a bridge at six in the morning.

But the answer in numbered points:

1. Reliability is a matter of maintenance as much as age. A car that gets its oil changed, its fluids checked and its small problems fixed early can run a very long time. A car that is neglected will be a headache at any age.
2. A repair fund is a warranty you own. The $193.04 a month in the plan above builds a cushion for the surprise. A warranty is a prepaid repair fund from the manufacturer, and the cost is built into the price of the car.
3. Safety is a reason to replace some cars, not all of them. A family may reasonably decide to replace a car whose safety equipment is badly out of date, or whose repairs have become a risk. The question is whether the benefit is worth the cost, and the answer is often "not yet."
4. The gamble on the other side is bigger. Locking into a $693 payment commits your income for five years. If a job is lost or hours are cut, that payment does not shrink. A paid-off car, by contrast, is flexible: if money gets tight, you can park the savings plan and keep driving.

When replacing a car does make sense

I am not preaching that you should drive a rust bucket into the ground. There are good reasons to replace a vehicle, and a family should recognize them.

• The repairs now exceed the value. When a single repair costs more than the car is worth, or when the repairs have become frequent and large, the car has stopped paying for itself.
• It is unsafe. Brakes, steering, structural rust or recalls that cannot be remedied. Safety is not a place to squeeze.
• It no longer does the job. A growing family, a new commute that is much longer, or a change in work that requires a different kind of vehicle.
• It is making you late or unreliable at a job that depends on it. The cost of a lost job outweighs a payment.
• You have the cash. If you have been saving the old payment for years, you may be able to pay cash for the next car, or finance a modest amount for a short time. That is the point of the plan: the next car is bought from a position of strength.

The rule of thumb is to replace the car when the numbers say so, not when the commercial says so. A replacement is a financial decision with a dollar figure. Treat it like one. Give Every Dollar a Job Before the Month Starts, the Zero-Based Budget is a good way to give the freed-up payment a destination, and Carrying a Balance Builds Credit and Six Other Borrowing Myths, Tested covers the car-payment-forever myth among others.

A word about the larger point

Behind this arithmetic is a principle that goes well beyond cars. A culture that tells you to want the new thing is a culture that profits when you do. The old American virtues of thrift, maintenance and making do were not nostalgia. They were a form of freedom, because a person who owes less answers to fewer people. Benjamin Franklin's maxims on the subject, collected in Benjamin Franklin's The Way to Wealth, Read Line by Line for Modern Savers, would make a perfectly good bumper sticker for the paid-off car: a penny saved is real money, and a payment avoided is a raise earned.

I find something almost comic in the idea that the most radical financial move available to many families is to keep driving the thing in the driveway. There is no seminar, no secret and no newsletter. There is a Saturday spent changing the oil and a decision to let the old payment go to work for you. For families who want a place to put the savings, Pay the Tax Now or Pay It Later? Traditional and Roth Accounts Side by Side explains the accounts.

The case in brief

1. On the illustrative $35,000 car financed at 7 percent for 60 months, the payment is about $693.04 and the total interest about $6,582.52.
2. New cars lose value fastest early, so by the time the loan ends the steepest part of the depreciation is over, and each added year of driving is the cheapest.
3. Even generous repair assumptions, $1,500 to $3,000 a year, cost far less than the $8,316 a year of the payment, especially if you fund repairs in advance.
4. Saving $500 a month of the old payment for ten years at an assumed 5 percent grows to about $77,641, a raise of $6,000 a year that compounds, though real returns will vary.
5. Replace the car when repairs exceed its value, when it is unsafe or no longer fits the job, and do it from savings when you can.

What you can do: this week, look up your car's payoff date and write down what you will do with the old payment, as a specific monthly amount and where it will go.