10% Rule and Real Life Car Stories
Wake up and smell the coffee, that’s what it feels like once you realize where your money is going, most people are shocked at how much they are spending on eating out, groceries, cable, shopping, cell phones, and all the other little ones that certainly add up. The Big 3 as I like to call them are what really impact your financial future because they are the biggest, which is housing, transportation, and food. I want to tackle transportation aka the big fat car loan that’s killing your wallet and preventing you from sending your kids to college, and stopping you from golfing every weekend.
I have pretty strong views on cars and car loans in general. You can read about possibly my biggest financial mistake and the Mercedes Benz I owned that has made me this way. Many financial bloggers and personal finance experts talk about buying a car and how much you should be spending, let me start out with my favorite from the Financial Samurai, which goes into detail and confirms many of my beliefs about how much you should be spending on a car.
There is certainly more than one school of thought on the details of purchasing a car, but this is where I stand. If you plan on achieving financial independence you
should MUST follow the 10% rule. It simply states that your vehicle purchase should be no more than 10% of your gross household income.
10% or less on buying a car is for the financial hero out there who wants to be financially independent yesterday and knows that driving around in a brand new Toyota Camry when they are making 50K is not the fastest way to get there. They will be dishing out a $400 car payment for the next 5 years, not factoring in any of the normal costs of gas, insurance, and maintenance. I tend to agree with the charts above from the Financial Samurai, but I think they could be simplified into 3 categories. Those who want financial independence as soon as humanly possible(the 10%ers), next up those who live within their means, plan to work their entire adult lives, are happy with driving 2 vehicles they are not keeping up with the Joneses but they are not far off, they probably own a Toyota Camry and a SUV because they “need” it for the kids, they make good money probably in that 100-150K range, but the cars are just under half of that (50% or less, living the “I need this car dream”), and finally the 3rd category is the guy keeping up with the Joneses, he’s buying the Range Rover because he has a cool job in the city, doesn’t matter if it’s over half his annual salary, this car is sweetmeat, he tells himself that he can “afford” the payments, which he can just like I can afford to buy 100 Snuggies to wear on a daily basis, that doesn’t mean it’s a good idea.(50% or more, the “I can afford it, I earned it, you only live once” category).
I think this is where so many everyday people make a financial mistake; the biggest problem is it repeats every 4 or 5 years. In most cases an everyday vehicle is needed, I don’t suggest that it is not. If you want to make big gains in your financial independence, retirement, and overall way of life I suggest sticking in the 0%-25% range anything above this is asking for trouble. Over the past few months I surprisingly have encountered numerous examples of real life situations, I won’t be giving out any names and I will do my best to paint an estimated financial picture, here they are Real Life Car Stories:
Single and Loving It. Over the weekend I was golfing and when we finished we all went back to our vehicles, when one of the guys mentioned how he liked the other guy’s car, turns out it was nice and expensive. He had purchased a new 3 series BMW which according to Financial Samurai cheat sheet would fall in the range of making 250K to 500K, I am certain he is not. He may have bought the car with cash, runs a small business with his new mobile text marketing campaign, maybe he put down a large down payment, I honestly don’t know, but I know he is failing the 10% rule. He has a lot of great things going for him, he has no student loans, to my knowledge no credit card debt, lives with friends in a house so a very small payment for housing. Housing is nice and low, his car payment is nice and high, and I’ll assume he is somewhere in the middle on food and eating out. How’s he doing? Some people would say he’s great, I would say he is asking to work forever, and his new expectation on a car is going to be the same, in 2020 or even sooner he will want a new BMW and start the same process over. If you assume he’s making 100K, the new Beamer is costing him a cool 40% of his salary, not cool. If I were him I would sell the car and buy something in the 5-10K range, how about an old Toyota Corolla?
Baby and Insurance Check. Congratulations you are having a baby!!! Or should I say $$$, but a child is priceless and they need a safety certified tank to haul their precious child around and it must be brand new, nothing else will suffice. Upon the good news of hearing they were having a baby, the car was damaged in flood, but they received an insurance check! Insurance lottery congrats, those monthly payments finally paid off. Let’s assume the car was a little older and they received a check for 5K, not bad right? Baby and Insurance Check want a bigger, better, newer vehicle, certified tank to haul the kiddos and a fatty car loan to go with it. I heard multiple times that they “need” a new car and remember we NEED 2 reliable cars, not want was the direct quote from Baby and Youi Insurance Check. Obviously a vehicle cannot be purchased with 5K alone! What about all the money you have saved up for the car? Nada! Yeah definitely go and grab a loan during one of the most expensive times in your life, make sure when costs are rising to go and grab some more payments that would be perfect, I say with as much sarcasm as humanly possible. If I were her, I would go and buy a nice used dependable vehicle for about 2 or 3K and save the rest for the baby costs and in case I need any maintenance in the first couple months. They already have one vehicle, adding another one at a low cost is the right move for me.
2 is Better than 1. Meet a happily married very frugal couple, they are probably like many of us who read and write on this very blog. They have 2 good incomes, both with older vehicles that are paid off and in working condition; they wouldn’t mind retiring early, something like 50 or 55 sounds great to them. They are saving up for retirement and any major purchases they need along the way. As luck would have it, Mr. 2 is Better than 1 truck is on its last leg, he has been saving since he paid off his truck and has enough cash to buy a brand new one. Let’s assume the truck is in the 30K-40K range, he’s paying with cash I probably can’t argue too much right? I’ll hold off on answering. Mrs. 2 is Better than 1 goes along and figures why not I have the cash and my car isn’t in great shape, I want a better, newer vehicle in that same 30K-40K range, so consider it all taken care because of course 2 is better than 1. I don’t know how much they make, but using the high price range of the vehicles it’s safe to say they are not making 800K! Well let’s assume they make 200K and they spent 80K on 2 vehicles, which is 40% of their annual income, that’s not any different than Single and Loving It from above! But they paid cash this is what sets them apart, not by a huge amount, but not having a large payment does make a difference. I think they made 2 or 3 right moves, but if their plan is to retire early don’t you want to make that sacrifice today and not buy 2 brand new vehicles? Couldn’t you have kept the total closer to 25% of the 200K and purchased 2 used vehicles because cars are depreciating vehicles, when’s the last time you heard someone say they retired early because their Ford Raptor really beat the market and went up 12% this year? Never, because it doesn’t happen. They saved money for a vehicle, paid cash, the only mistake is going above 10-25% of their household income, it’s not going to hurt them today or even tomorrow, but that 80K could be the difference in retiring at 50 and 55.
All in all I think every financial decision has a positive and a negative involved with it. Buy a new BMW that looks great and impresses friends, positive. Have a $400 car payment for 5 years, negative. It comes down to a simple choice: Are you willing to live with the negative and how it affects your future? I am not ready for the negative of buying a new BMW, I’m riding the train everyday taking the negative now of not enjoying a cushy, faster ride to work, instead I want the positive of no payments and paying my debt off faster for an early retirement.
If you want to achieve financial independence in the fastest way possible, you must adhere to the 10% rule, I know I do. If you have chosen a life where you want to be ahead of the game financially, you should be somewhere in the 0%-25% range, anything over that and you putting yourself in a negative situation that will affect your future, are you ready to make that negative into a positive and sell your new Range Rover?