If you’re thinking about buying a car, it’s important to take into account your budget before you hit the dealerships or online offerings. You’ll want to know, “Just how much car can I afford?” While it may seem like a difficult thing to figure out, it is really quite straight forward. Follow the steps outlined below to figure out your budget for your next new-to-you car.
How can you calculate how much car you can afford?
To calculate how much car you can afford, you should follow two financial rules that financial experts recommend:
- Don’t spend more than 10% of your take-home pay on a car loan or lease.
- Your total car expenses shouldn’t be more than 20% of your take-home, either. Total car expenses include things like maintenance, repairs, gas, insurance, and parking.
To figure out your take-home pay, take a look at your paycheck. You can either use your annual take-home pay or your monthly take-home pay to figure out what your budget might be. If you use your annual take-home pay, be sure to divide it into twelve months to find out what you bring home monthly. Once you have your monthly income figured out, multiply that number by .01 or 10% to figure out what your monthly budget might be for a car loan payment. Multiply your take-home income by 20% or 0.2 to figure out what your total monthly budget might be for all your car-related expenses. When you’re figuring out your budget be sure to take into account any outstanding regular debts you might have. Debts might include things like credit cards, student loans, mortgage payments, business loans or any other finance charges you might have to cover on a monthly basis. Be sure to put your car payment estimate in the context of your life and other costs to ensure you find the right balance. There are a few pieces of information that you will need to collect before you start shopping, however. They include:
- Your credit score: This is available through the credit reporting bureaus or through your annual free credit report. You are entitled to one free credit report each year from all three credit bureaus, and you can choose to access your credit score for an additional fee. Your credit score determines the interest rate and APR you can get from lenders. The worse your credit is, the higher the interest rate will be for a car loan.
- The length of your loan or lease you want: Most car loans range in length from 24 to 72 months. In some cases, lenders may even offer 84-month loans (that’s a seven-year loan!) The longer the loan, the more you will pay in interest, which means the cost of the loan will be higher in the long run. Be sure that you know what you are getting into when signing up for a longer loan.
- How much cash you want to put down on the car (or the value of your trade-in): When you shop for a car, you can either use a trade-in (a car you currently own) or a down payment to reduce the cost of the new or new-to-you-vehicle. In either case, the value of the trade-in and/or the amount you decide to put down on the vehicle will reduce your total loan. If you’re purchasing a car, we recommend putting down 20% on a vehicle. That will cover taxes, title and a bit of the principle and help prevent being upside down in a loan. We don’t recommend putting down more than tax and title on a lease since it doesn’t make good financial sense.
- Tax rate in your state: You should have a good idea of what sales tax might be in your state so that you can add that cost into your calculations. You’ll need to pay taxes and title whether you lease or buy a vehicle.
- APR or Interest rate: The average APR or annual percentage rates for auto loans is currently 4.29%. Your APR or interest rate will change based on your credit score. It will go up if you have bad credit. It will go down if you have good credit. The APR takes into account the total cost of a loan, including fees. The interest rate, on the other hand, only takes into account the interest you’ll pay on the loan.
Once you have figured out how much money you can spend on a car (your monthly budget), and collected all the information above, you can use an auto loan calculator to figure out what a right loan or lease might look like for you.
How much car can I afford based on salary?
To figure out how much car you can afford based on salary, you should take into account how much money you bring home each month after taxes. While your annual salary may look good on paper, it can give you a false sense of what you can actually afford. Use the 10% and 20% rules noted above to figure out what your monthly budget is for car-related payments. As an example, let’s say that you take home $3,000 per month in after-tax pay. If you multiply $3,000 by 10%, you’ll discover that your car payments should only come to $300 per month. If you take that same $3000 and multiply it by 20%, you’ll find that your total car expenses should only come to $600 per month. That includes maintenance, parking, repairs, gas, and insurance.
How much car can I afford to lease?
Deciding to lease can make sense in some situations, and figuring out how much car you can afford to lease is an important thing to know. To figure out how much car you can lease, make sure you apply the same 10% and 20% rules mentioned above. Once you have your monthly budget, you can use a car-lease-calculator to figure out how much car you can afford to lease. Most car leases are 36-months, though you can choose leases that are as short as 24 months, or as long as 60 months or five years. In general, the longer you lease, the lower your monthly payment will be. Just remember that extending the length of your lease means that you will pay more in the long run, and you still won’t own the vehicle at the end of the lease term. The benefits of leasing are that you can get a new car every few years, and you typically only need to put down tax and title fees. The drawbacks of a lease include that you won’t own the car at the end of the lease, and the fees can be steep if you go over the mileage or have excess wear and tear on the vehicle. In general, most leases make it attractive to own a slightly more expensive vehicle than you might be able to afford to buy.
What financing allows me to buy the most car?
If you’re wondering, “What financing allows me to buy the most car,” the answer is often: The one that best fits your financial situation. Everyone’s financial situation is different, and there is no one-size-fits-all answer to this question. In most cases, you can likely afford more car if you lease. Buying a car, in general, is more expensive but, at the end of the loan, you can sell the vehicle and recoup the money you spent. With a lease, you don’t have that option since you have to return the vehicle to the dealer.
Think of the buying versus leasing debate like you think about owning or renting a home. If you buy a home, you have to take out a mortgage or rely on loans to pay for it. When you have paid off the mortgage (or even before then), you can sell the home and get some of that money back. If you lease or rent a home, you never get that money back. You don’t own anything to sell at the end of the home lease, and you don’t have a house to live in. In most cases, financial experts recommend buying a car (or a house) if you can afford it.
What monthly car payment can I afford?
To figure out what monthly car payment you can afford, use the 10% and 20% rules above. If you are strictly interested in payment alone, use the 10% rule. Figure out what your after-tax take-home pay is, and then multiply that number by 0.10 or 10%. That number is the maximum price that financial experts recommend that you pay for a car payment. Some financial experts say that you can go as high as 15% of your take-home pay as well. The risk here is that you are stretching yourself a bit more financially, and if something goes sideways, you could end up in a bad financial situation. It’s always better to be a bit more conservative when it comes to finances. You can play with the length of the loan, and the interest rate to get payments down but know that there are drawbacks to taking out longer loans (since you will pay more for the loan in the long run). It’s always a great idea to get the best APR or interest rate you possibly can, and cleaning up your credit can help with that.
Should I take an auto loan for 84 months?
There are very few instances where it makes sense to take out an auto loan for more than 60 months. If you are extending the term of your loan to 84 months (or seven years!) to afford a vehicle, you are really stretching the limits of your finances, and that is almost never a good idea. While the idea of an 84-month loan might be appealing if you want to buy a nicer car and have lower payments, the downsides are substantial. You’ll end up paying more for the car in the long run than you would have had you taken out a shorter loan and it’s very likely that you will end up owing more than the car is worth should you want to sell the vehicle before you have completely paid the loan off. The other negative of taking out an 84-month loan is that you tie up your money in a vehicle rather than say, investing it elsewhere like a retirement account, mortgage, college savings, or other investment. Take into consideration the total cost of the loan and weigh your options before deciding to sign onto a longer-term loan.
The Bottom Line
Deciding just, “how much car I can afford,” can seem like a really tricky financial decision, but if you follow the 10% and 20% rules above, you are more likely to make a great choice and ensure that your finances remain in good health in the long term. Choosing a loan or lease that suits your financial needs as well as your transportation needs can save you time, money, and potential pitfalls in the long run.