How to Pay for Your Tesla Now

A few weeks ago we witnessed as a species the largest product offering in history as Elon Musk announced the opening of pre-orders for the amazing Model 3 from Tesla. For $1,000, 325,000 people agreed to purchase the car when it becomes available (and the number of buyers continues to grow). At a price point of $35,000 each that represents a revenue windfall of $11,375,000,000, including an immediate influx of $325,000,000 right now! Today I’m going to explain how you can pay for your Tesla right now and about buying new cars in general.

A brief history of car buying

For a short period of time at the dawn of the automotive age the primary business model of auto manufacturers was to sell cars for a profit. If you wanted to buy a car but didn’t have enough money up front you could save up for it slowly using a “layaway” plan in which you paid the dealership a payment each month until you had enough to buy in full the car that you wanted. Then in the early 1920s General Motors had a realization: they could sell a car to people who couldn’t afford it and make more from the interest on a car loan to have the car right now than they could selling the car itself! The GM corporation was no dummy and understood car loans meant harnessing the most powerful force in the universe for themselves by pitting compound interest against their customers.

Car loans proved to be so profitable they fundamentally changed how the automotive industry worked forever. In fact, when Henry Ford, the inventor of the consumer car market, didn’t buy into the idea that people would be willing to take a hit to their finances from a car loan his company lost market share to GM and had to play catchup, eventually giving in and offering loans to fleece its customers and enjoy bigger profits. So what does that have to do with Elon Musk and the Model 3? I’m so glad you asked.

The bad math of financing your auto

Auto loan business in the United States is booming, with some estimates putting total auto debt in the United States at nearly one trillion dollars. More than almost any other consumer good, your car is a measure of how well you’re keeping up with the Joneses. It’s a status symbol that represents freedom and Americans overwhelmingly favor having the kind of car they want at whatever expense comes with it. That concession to the millions spent marketing vehicles each year is how we spend billions on owning our status symbols.

The truth of financing a car is dirtier than financing most other purchases. A home bought with a loan can potentially increase in value, or likely hold much of its own value. An education bought with someone else’s money pays dividends for decades through your life leading to career earnings tens or hundreds of thousands of dollars higher than those who go without getting their degree. Cars? The second you drive a brand new vehicle off a car lot it loses as much as 11% of its value. That’s an extraordinary loss of money from simply using your vehicle for what it’s supposed to be used for!

When you finance that vehicle purchase? Your losses are even higher! With a subprime loan, which make up about 20% of the total car loans in a year, you might pay more than double the price of your car over the course of the loan life. Miss a payment? They’ll flip a kill switch which renders your vehicle inoperable. Financing your vehicle purchase is hemorrhaging money to your car dealership so that you can have a rapidly devaluing “asset” that sits unused in a parking lot 90+% of the time you own it.

Buying a new car magnifies the situation even further! New cars depreciate (lose value) faster than used cars. In the first year of ownership your new car can lose as much as a fifth of its value. Now you’re paying someone two times the value of an asset that’s immediately a tenth less valuable than before you purchased it and will be worth only 4/5ths of its worth by the end of the year. Meanwhile you will continue to pay for the vehicle as though it were still worth what you paid for it when you bought it.

That math does not add up to a friendly outcome for your pocketbook.

Saving on car buying

The solution to saving when you buy your car is twofold:

• Buy quality used vehicles
• Don’t finance them

When we convince ourselves we have to buy a new car because it’s more reliable, or we like the smell, or we want our neighbors to think we’re richer than we are we’re falling into the Keeping Up With the Joneses trap and paying thousands of dollars to do so. If instead we make the decision to buy a quality used vehicle we’re letting our sucker neighbors pay thousands of dollars in depreciation and lost value on their vehicle so that we can scoop it up for a bargain. And repairs? We can determine the risks for repairs and estimate costs using technology like the Edmunds Total Cost of Ownership calculator. The lower cost of a used vehicle means needing to finance less or providing us a better window to save for the entire vehicle purchase (more on that in a moment) and not having to eat the stiff upfront costs of depreciation.

As for financing? We already know debt is a sucker’s bet that should be avoided because it pits the universe’s most powerful force against us. Buying a car remains one of the largest purchases most Americans make in a given decade, and having enough cash on hand to buy even a used vehicle is challenging. If you plan on buying a different car every eight years at a price point of $10,000 you’ll need to start saving for the vehicle in advance to ensure you don’t need to finance. How much would you have to save? Eight years is 96 months. Split the $10,000 out over the course of those months and you wind up with a need of about $100 each month. When you put it in those terms, buying your next car used seems a lot more reasonable to do without needing to finance. Utilize the most powerful financial tool in the world to carve out $100 from your budget to set aside in your “next car” account and save now. Need help cutting things from your budget? See if you’re spending too much on these items.

But I preordered a Tesla!

 

Model 3 photo courtesy of Tesla Motors.

That is a beautiful car. And Elon Musk is an inspiring guy (check out this great, if lengthy, interview with him from Wait But Why). The future of electrical vehicles is incredibly exciting, and a Tesla vehicle is a very rare creature that can actually get better over time with automatic software upgrades that roll out to customers for free as the company comes up with new ways to improve their vehicles. Imagine waking up one morning and your car has gained the ability to drive itself over night. That literally happened to Tesla vehicles not long ago.

So you’re excited to be an early adopter of the Model 3, the first mass market electric vehicle on offer from Tesla Motors. I don’t blame you; even Mrs. Stark and I are considering pulling the trigger on the sexy sedan (we’ll wait to buy until it’s actually available). You came up with $1,000 as your reservation payment even though the car doesn’t come out until sometime in 2017 (or later depending on who you ask). The rest of the $34,000 you’ll need to make the purchase? Meh, you can just finance it like you’ve always done.

But wait! There’s a better way! You can pay for your Tesla right now! Instead of letting Elon use compound interest, you can actually put your car-buying dollars to work earning you more money right now. How? By paying yourself the monthly car payment you’ll make in the future starting today.

The Model 3 has a sticker price of $35,000. It’s slated to release in late 2017. If we assume “late” means real late, December late, then we have 20 months to save the money to pay for the vehicle in full at the time we want to purchase it. To pull it off we’ll need to set aside $1,750 each month to make sure we can fully afford the vehicle without financing.

Except that we already paid $1,000 for our refundable reservation which knocks our total savings target down to $34,000, or just $1,700/month. Of course, you likely already own a vehicle which you won’t be needing after you buy your futuristic emissions free space car, so that’s going up for sale. I don’t know what you’ll get for that vehicle, so we’re going to do some estimating and call the value $5,000 (you might get more or less depending on the vehicle you’re selling). That knocks your total for your Model 3 down to $29,000, or a $1,450 monthly payment.

Now I love Elon Musk and what Tesla Motors is trying to accomplish. But the fact of the matter is delivering futuristic vehicles on a short delivery timeframe is very difficult even for a world class organization. In fact, Tesla has failed to deliver on time before. Likelier estimates of the actual delivery of your Model 3 will be closer to 2019 than 2017. That means your savings rate has longer to work in your favor; if instead of December 2017 the vehicle delivers in December 2019 you have 44 months to save instead of 20. That means your savings is down to just $659 each month.

We’re still not done! You’re saving your income in a secure, low-risk bank account so it’s liquid and ready for you to pull out while being protected from big swings in the market. Even with a boring bank account you can still earn as much as 1% interest on your money through a low-fee online bank account which gets to compound for four years. Hiring your money to work for itself can mean you wind up with as much as $2,400 in the account, or the equivalent of four monthly payments! “But Bill, doesn’t inflation eat into that compounding at a rate higher than 1%?” Yes, normally that would be the case as inflation hovers between 2-3% in the States annually. But the Model 3 has a static sticker price of $35,000 meaning we know the target we have to hit and it’s not changing. Inflation only affects our dollars compounding when the cost of the goods are going to go up as a result of it. Our future Tesla is staying put at $35,000 in total costs.

Finally we have special tax incentives to get your price for the car even lower. We’ve talked about how the government wants you to pay the lowest amount in taxes possible and a family of three earning $100k can easily pay as little as $11. Electric cars are no stranger to this treatment with the government offering you as much as $7,500 off the cost of your car in tax savings for buying all electric. That drops your $29,000 payment to $21,500 or $1,075/month on a 20 month plan or just $488/month on the 2019 plan. If your state offers its own tax incentives, that price will go even lower!

What does preparing for your Model 3 payment now do for you? Besides prove that you can afford the vehicle on your budget by making the payments now you prove ole’ Henry Ford correct: layaway is a better deal for customers than financing because you’re not paying interest, you’re earning it. Paying now means avoiding financing which saves you money. How much? On a 10 year car loan at 5% for the full $34,000 your Model 3 will cost you $9,274.73 in interest. What would you do for $9,300? Preparing to pay for your Tesla now is all it takes to ensure you have access to that money down the road.

The moral of the car story

At the end of the day, financing a quickly depreciating asset is a sucker’s bet. When you can, buy quality used cars for which you pay cash in full. If you’re already making the reservation for your Model 3 from Tesla, do yourself a favor and start preparing to pay for the entire vehicle now. Doing so ensures your budget can handle the hit of dropping $35,000 on a car and it will save you over $9,000 in interest over the long-term. Plus at a monthly payment rate as low as sub-$500 you can save now in a responsible fashion that doesn’t break your bank. Even if you don’t get to the full $35,000 you’ll need by release, saving some amount will reduce the amount you need to finance saving you interest payments and could lower the rate of your loan which saves you thousands long-term. Start saving today (and expect a followup if the missus and I do decide to pull the trigger on buying a brand new car for the first time ever).

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