Why you should pay cash for your next car

By Sierra Black

Let's pretend you've just made your last car payment. You did the smart thing and bought your car slightly used, so you have several good years left to drive it, debt-free.

What are you going to do with all the money you've been putting into your car payment each month? Here's a good idea: keep making car payments. (Huh?)

Next month, when your payment would normally be due, make a car payment to yourself. Just put the amount of your monthly car payment into a high-interest savings account. Then when the time comes to buy a new car, you can pay cash and drive away from the dealership debt-free.

Self-financing your next car

To stay focused on your goal, set up a high-yield savings account with an online bank. If you're serious about managing your personal finances, you may have one of these already. You can create a sub-account dedicated just to car savings, and see your nest egg grow each month.

Setting up an automatic savings contribution to your new account makes the process simple. You never have to think about it, but the money will be there when you need it.

Get paid interest instead of paying it

The key difference is that instead of paying interest to the bank each month with your car payment, the bank pays you. The rates may be low, but over time interest adds up big.

Say you have (for the sake of nice round numbers) a $15,000 car loan at 5 percent interest. Over the life of a 5-year loan, you'll pay almost $2,000 in interest. If you deposited the monthly car payment of about $284 in a bank account instead, you'd earn about $575 in interest. Overall, you're more than $2,500 richer if you bank your payments before buying the car instead of paying interest on a car loan.

Stay free

The American love affair with the automobile is, at root, about freedom. You may not feel like your car is a symbol of personal freedom when you use it to drive to work every day, pick the kids up from school and run errands. But having a debt-free car gives you an important kind of freedom: the freedom to sell it if you need to.

Owning your car free and clear leaves you more flexible for lifestyle changes that may come up. Want to take a job in Europe? Go ahead and sell the car to your sister for a song. Want to maintain it like a museum piece and get top dollar for it when it becomes a collectors item? You can do that, too.

Whatever you decide to do, you'll have dodged the debt bullet on your next car, and you'll have come out a few thousand dollars ahead. That's all the more fuel for your high-yield savings account.