How to Save for Your Next Big Purchase
If you’re thinking about buying a “big ticket item” — a car, or a house/condo, or a boat, or even a home appliance like a TV, fridge, washer and dryer, or anything else that you won’t be able to pay for upfront, in cash — it’s a good idea to put money aside for a down payment.
But, if you can’t pay cash, it’s a good idea to have money put aside for a down payment.
As I discussed in the blog post Lessons Learned: Buying a New Car, any big purchase that you have to get a loan for often has a 20-25% purchasing fee built into the loan. If you put down a down payment of 20% of the sales cost, you effectively eliminate the purchasing fee. If you put down 25% or more of the sales cost, even better.
Another important aspect of taking on a loan is making sure that you can afford the monthly payments before you buy the item. If you can’t, then you have no business buying the item in the first place, and owning it will only make your life more stressful, and no one wants that.
But, with a little foresight, you can kill two birds with one stone, saving for the down payment and making sure your current income can support the payments.
Say you’re going to buy a used car and the average price for the one you’re looking for is $10,000. Since you probably don’t have $10,000 just lying around, you’ll need to get a loan for it.
Car price: $10,000.
Down payment: $2,000 (20% of the sales price).
Sales Tax: Depends on your state. For these purposes, I’ll go with 6%.
Interest rate: 7% — Can range from 4-8%, depending on your credit history and credit score (See: “Know Your Credit Score“).
Term (Months): 36 months is the most common — The term can range from 24 to 72 months; the longer the term, the lower the monthly payment, but the more interest you’ll pay over the course of the loan, increasing the cost of the item.
Monthly Rate: With the above information, the monthly payment is $265.
Use the car loan calculator at cars.com.
Okay, but now that you have that information, what do you do with it?
The best thing to is to start living as though you’re already making that payment. (In my family this is affectionately known as the “Peggy Pingel Payment Plan,” named for my brilliant aunt.)
For the next four months, take $265 and put it into a savings account. At the end of those four months, if you’ve been able to save the money, you should have $1,060 saved, which puts you well on your way to the $2,000 down payment.
If you are able to consistently put aside $265 a month (or more), continue to do so until you reach your target goal of $2,000 (should take three months more, or less if you’re able to save more each month) and then go get that car!
If you aren’t able to consistently put aside $265 a month, then you need to reconsider your options. You can:
- put off buying a new car until you can afford the payments,
- find a less expensive car, one that you can pay for with cash, or that fits in your current budget, or
- extend the loan term by 12 to 36 months.
The only time I would recommend Option C is if you know that you’ll be able to overpay on the car payment more often than not (at least every other month). If not, you’ll end up paying more than the car is worth due to the interest (over 13% more, according to the loan interest calculator at BankRate.com.
The savings plan described above can, and should, be applied to almost any big-ticket purchase, be it a house, or a boat, or a home appliance.
- Mortgage Loan Payment Calculator with amortization schedule
- Auto Loan Payment Calculator with amoritization schedule (these results are slightly different than the calculator at cars.com, but this calculator doesn’t consider if you make a down payment.)
- Calculate the monthly payment on any loan
- Calculate the interest over the life of a loan
Amoritization (n): “The gradual elimination of a liability, such as a mortgage, in regular payments over a specified period of time. Such payments must be sufficient to cover both principal and interest.” (1)
Resources for Further Reading
- Lessons Learned: Buying a New Car
- Lessons Learned: Buying My First Used Car
- Cars.com Auto Loan Calculator