Are you in the market for a new or new-to-you car?
If so, you’ve probably wondered “How much car can I afford?”
While your local car dealership might be happy to tell you the sky’s the limit regarding your car purchase, your personal budget might be telling you a different story.
Spending more than you can afford on a car turns that car from a blessing into a burden.
How Much Should I Spend on a Car?
Deciding how much to spend on a car starts with knowing your current financial numbers. You'll need to know your current income, expenses, and savings amounts.
Know Your Numbers
There are several financial factors that can influence how much you should spend on a car. The amount of money you earn, of course, needs to be taken into account.
When determining how much you earn, always use your net take-home pay to start with. From there, factor in the other financial obligations you have.
In other words, look at your budget. If you don’t normally use one, now is a good time to start. Having a clear view of all other monthly financial obligations will help you better determine how much you can afford.
The 50-30-20 budget plan can be helpful. In short, the 50-30-20 budget plan works like this:
- 50 percent of your budget goes toward must-have and must-do obligations, such as housing expenses and child care
- 20 percent of your budget goes toward savings and debt obligations
- 30 percent of your budget covers unnecessary expenses and “fun” money
There are many ways to design a budget, but the 50-30-20 budget gives you a good place to start. It will certainly point out of there are any areas that are totally out of whack.
What Do You Have in Savings?
Having a healthy savings account balance is important when making a car purchase as well. If you don’t have an emergency fund with a balance equal to three to six months’ worth of expenses, building that emergency fund up should be a priority.
With an added car payment, having a plush savings balance will help you ensure you can cover the new payment even if you hit a financial bump. Or, for instance, if the car needs repairs.
Determine the Total Cost of the Car
Once you have looked at your budget and determined the amount of money per month you are comfortable spending on a car you'll want to be clear on the total car costs before you make your purchase. Affording a new car isn’t simply about the payment.
There are several other costs associated with car ownership, such as:
- Insurance policy costs
- Fuel and parking costs
- Maintenance and repair costs
You can call your insurance company ahead of time and get a quote for the new vehicle you're considering. If you are still trying to narrow down what type of car you want check out this post from Insure.com. It lists the most and the least expensive cars to insure.
Fuel costs are fairly easy to determine. A Google search will give you the MPGs of any car you could think of. Compare that to your current car to see if your costs will change.
Maintenance and repair costs can be harder to determine but you can get an idea by using averages across a brand. Here's an article from Autowise that displays the cheapest and most expensive cars to maintain.
Be sure to factor in an accurate estimate of these additional car ownership costs as you determine a purchase price and payment amount you’re comfortable with.
Get the Right Kind of Car Loan
Doing your due diligence as you shop for a car loan is important as well. You do not have to get financing through the dealership. You will likely do better getting a loan yourself through your bank. At the very least, have an understanding of what rate you would qualify for before heading into the dealership so you know if they are offering you a fair rate.
Know that your current credit score will likely affect the loan rate you pay if you borrow money to purchase a vehicle. The higher your credit score, the lower rate you qualify for, and the difference can be vast.
In Experian’s State of the Automotive Finance Market, a quarterly report from Experian, we see the wide range of interest rates auto loan holders pay based on their credit score. Ranging from about 4% for the lowest risk borrowers, up to just over 20% for the highest risk borrowers.
To show you how much your credit score could affect your payment, let’s do a quick calculation. Let’s say you’re borrowing $25,000 for five years for your car purchase.
If you’ve got a credit score of 800 and are paying a four percent interest rate, your monthly payment on that loan would be $460. However, if you’ve got a credit score of 650 and are paying a 12 percent interest rate, your payment jumps up to $556 a month–almost a $100 a month difference.
As you can see, your credit score has a substantial impact on the interest rate you could pay for your car loan. As such, it’s important to work diligently to get–and keep–your credit score as high as possible.
Beware Of The Monthly Payment Myth
In addition, it’s important that you don’t fall for the monthly payment myth. It’s common for car sales teams and auto loan lenders to focus on a vehicle’s monthly payment amount as opposed to the total price of the car. In other words, “If I can afford the payment, I can afford the car.”
Many times buyers don't even know what the sales price of the car actually is! When you are negotiating with a salesman, stay focused on the actual sales price, and worry about the monthly payment during the financing.
Also, the longer term you sign up for on your auto loan, the more interest you’ll pay over time.
For example, let’s say you sign up for a $553 per month payment for a 4-year term. If you’re paying a five percent interest rate, you can get a $25,000 car. You’ll pay $1,561 in interest.
Conversely, let’s take that same $553 a month payment and stretch it out to a 6-year term, you can get a $36,400 car. However, you’ll have payments for two extra years and you’ll pay over double the amount of interest you pay, at $3,420.
If you only focus on the monthly payment you wouldn't even realize you were spending 45% more for the car.
Consider Paying Cash
Another option many financial experts suggest is to limit your car buying power to the amount of money you have saved in cash. By using the cash you’ve already saved up to purchase a car, you may not be able to get as nice or as new of a car as you’d originally had in mind, especially if you need to get a car right away.
However, not having car payments would allow you to save the monthly amount you would have been spending to pay cash for a better car in the future.
When it comes down to it, only you can decide how much car you can afford. Possibly one of the most important tips you can heed is to beware of taking on a car payment amount or term that will substantially limit you financially.
In other words, don’t put yourself in a position where your car payment limits you from having other monetarily-driven fun in your life. Making sure your car gets you from A to B while meeting your transportation needs is really the most important factor.
It's up to you how much of your budget you want to devote to transportation. When shopping for a new car keep the focus on the actual sales price of the car, not the monthly payment. Also, remember that the costs of owning a car is more than just the purchase price. Insurance, gas, and maintenance will also play a part – so keep that in mind when shopping around.