Most of us know that debt is bad and equity is good. The 8th Great Wonder teaches us that the less debt we have, the more money we can invest, and the faster we can build wealth. But certain kinds of debt are worse than others and auto loans are one of the worst. Interest rates on auto loans tend to be higher than other kinds of debt, but more importantly, the asset being financed with the loan (the car) depreciates in value over time.
Think about some of the other things people borrow money to pay for;
While borrowing money generally prevents us from building wealth, few of us can purchase a house without a loan. However, houses tend to increase in value over long periods of time. There can be short-term decreases in certain markets, but as prices generally rise and payments are made, the homeowner's equity increases. As a result, a homeowner's net worth on average is substantially higher than that of a renter.
The skyrocketing price of an education makes it another purchase that requires many people to borrow. Similar to housing, a college education is not a guarantee to generate a return on investment, but statistics tell us that college educated people earn, on average, $1 million more over their careers than those without a degree. So while we'd prefer not to borrow, there is a potential financial payoff in the form of future earning power.
Back to car loans
Cars depreciate every day, and most will be worthless in under 10 years. So the idea of borrowing money and paying interest on that balance for something that will have no value in 10 years should make you sick. If it does, you'd much rather pay in cash.
But how if I don't have the cash?
Similar to houses and cars, few of us have enough cash to pay for a car without a loan. The good news is that if you're able to make your current car payments and are willing to drive your current car a little longer, you can buy your next car in cash. And once you buy one car in cash, buying the one after that in cash becomes even easier.
Here's how it works
Let's say you currently own a car that you bought in January 2016 for $30,000. You couldn't buy it in cash so you put down $5,000 and got a loan of $25,000 from the nice man at the dealership who had your best interest in mind. At an interest rate just above 3%, you're paying $450 per month and you have three years remaining on the loan before it's paid off.
The old you would've done what most people do. At the end of those three years, you'd be done with car payments, but that car that looked so good five years ago is no longer impressing the neighbors. So like any good American with no car payments, you'd march right back to the dealership to "upgrade" to a new car. After all you've been working hard and you deserve it. You would then continue in that perpetual cycle for the rest of your life, all while complaining how life is too expensive, everything is unfair and you can never seem to get ahead.
Being a reader of the 8th Great Wonder, the new you is too informed to make those mistakes. The new you is going to pay off the car in three years and then start paying yourself. Literally, you're going to start paying yourself that $450 per month that you were previously paying for your car. Then, for this first time, and this first time only, you're going to keep your car for an additional four years. Why? Because cars today are made to last soooo much longer than we actually drive them, and you'll be building up your cash reserve for your next car. Those extra four years you keep your car will allow you to pay yourself nearly $22,000 plus some interest, so let's call it $23,000. At this point you're going to buy a new (or used) car with $23,000 in cash. If you really want to spend more than that, you'll keep that old car a little longer while continuing to pay yourself $450 per month.
Here's the really fun part
Buying that first car with cash will feel great, but it's not the best part. The best part is what happens next. Having purchased that car with cash, you'll begin paying yourself that $450 per month from Day 1 of your new car. Your cash cushion will build up so fast that you won't need to drive this car for nine years like the last one. But being the financial expert you are, you'll keep that car for at least six years at which point you'll have $33,000 in cash! But it gets better, because after six years that car isn't dead yet and you're going to get something for it - let's call it $5,000. You now have $38,000 in cash. You'll pay about $28,000 for your next car and start Day 1 of the next car with $10,000 before even beginning to pay yourself that $450 per month. And you'll earn interest on all this extra money.
What was a perpetual cycle of debt and never getting ahead has now turned into a perpetual cycle of wealth. Apply this principle to more than just your cars and watch your wealth grow even faster. That's the 8th Great Wonder.