Content of the material
- 4 steps to determine how much car you can afford
- #1 Calculate your monthly car payment
- How much money should you spend on a car based on your salary?
- Should you pay cash or finance a car?
- Here’s why financing is almost always better than paying cash
- Heres why your budget is lower than you were hoping
- Consider your purchasing options
- Buying a used car
- Buying a new car
- Step 2: Consult your budget
- Reader Interactions
4 steps to determine how much car you can afford
Calculating how much car you can afford may help you save time and money in the long run. Several factors affect your auto loan rate, including:
- Your loan amount
- Your down payment
- Your loan term
- Your credit score
- The type of vehicle you choose (lease, used or new)
To help you find your monthly budget, we’ve outlined four steps below.
#1 Calculate your monthly car payment
Financial experts recommend spending no more than about 10% to 15% of your monthly take-home pay on an auto loan payment. These percentages do not factor in total car expenses, including gas, insurance, repairs and maintenance costs.
Use your annual income as a starting point to calculate how much car you can afford based on monthly payments. The table below shows examples of annual salaries and the monthly payment amount you should not exceed for a car loan.
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How much money should you spend on a car based on your salary?
The rule of thumb among many car-buying experts dictates that your car payment should total no more than 15% of your monthly net income, sometimes called your take-home pay (some might stretch this to 20%, but 15% is more conservative and therefore likely to make budgeting even easier). Your net income is the money you take home after federal, state and local income taxes have been deducted from your paycheck.
Note that this 15% is meant to cover just your car loan payment, and not ongoing car-related expenses like fuel, maintenance and insurance.
The idea behind the so-called 15% rule is that if you limit your monthly car loan payment — sometimes called a car note — to 15% or less of your net income, you’ll have enough money left over each month to cover the rest of life’s expenses, including the occasional financial curveball.
Should you pay cash or finance a car?
If you can afford to pay cash, should you?
Here’s why financing is almost always better than paying cash
On paper, paying cash makes much more sense. You don’t have to worry about a monthly payment, you don’t pay a dime of interest, it’s one-and-done.
However, there’s an opportunity cost to paying cash.
If you write Carmax a check for $15,000, that’s now $15,000 that you can’t invest and multiply.
To illustrate, let’s say you choose to finance instead of paying cash. You put 20% or $3,000 down, and set up autopay for your $300 monthly payment.
That leaves you with $12,000 today to play with.
- You could put it in an S&P 500 index fund where it could become $30,000 in five years.
- You could put it in your retirement account, where it could become $113,000 in 30 years.
As a general rule of thumb, it’s usually worth financing at a 2% interest rate or lower and stashing the cash in other places where it can grow much faster. As a cherry on top, financing with a low interest rate is better for your credit score.
For ideas on where to invest your extra car cash, check out 7 easy ways to start investing with little money.
Heres why your budget is lower than you were hoping
If your reaction to the Car Affordability Calculator was:
Bruh – that’s it? That’s all I can spend on a car?
Well, you wouldn’t be the first to feel that way.
I, too, felt that way back at my first job. Everyone I worked with was driving shiny new Mercs and BMWs to work, while my budget calculations said I could only afford a used Mazda at best.
I was making the same money as them, so… what gives?
Why can’t I afford a new Hemi-powered Charger or Lexus crossover like seemingly everyone else on the road?
The reality is that most Americans are driving cars that they can’t really afford. For the first quarter of 2022, Edmunds reported that the average new car loan term was a horrifying 70 months, with the average monthly payment reaching $648 for new cars.
This tells us that rather than considering a more affordable car, Americans are pushing out their car loan terms even farther, staying in debt longer, and simply paying way, way too much overall.
Remember, you’re sticking to the 35% rule for several reasons:
- You can still get top-rated crossovers, sports cars, etc. for under $15,000.
- You won’t run the risk of going underwater.
- You’ll be able to invest all the money you save – enabling you to achieve financial independence much faster (and even buy a much nicer car!).
Consider your purchasing options
If you’re on a tight budget, explore all of your options before purchasing a car. Several choices are available, including leasing or buying a used or new car.
A car lease allows you to essentially rent a car from a dealership for a certain length of time and mileage. It can be a good option since the monthly payments are lower than those for buying the car outright. However, keep in mind that you’ll have a mileage limit and the money you pay toward your car won’t bring any value to you.
Buying a used car
Purchasing a used car gives you more freedom than a car lease. Used cars tend to be priced significantly lower than new cars, making monthly payments more affordable. Additionally, car expenses such as insurance tend to be lower for used vehicles.
Buying a new car
If you want to purchase a new vehicle, do your research so you know which make and model you want. Knowing a car’s fair market value will help you negotiate the best deal possible at a dealership.
Step 2: Consult your budget
A good starting point is your budget. Experts say your total car expenses, including monthly payments, insurance, gas and maintenance, should be about 20 percent of your take-home monthly pay.
For non-math wizards, like me – Let’s say your monthly paycheck is $4,000. Then a safe estimate for car expenses is $800 per month.
Should you mention depreciation? If you decided to sell the car a year after buying it new, you’ll get a lot less for it than you paid.
I found this article to be very informative. Many Americans can’t do without a car, but few understand how much car they can afford. Keep on posting!
That’s an issue I’m running into: the car that I want/need is too pricey for my taste. I don’t know what to really do when it comes to that because the dealership has to make some type of profit as well yet I want to get it at a price that’s reasonable.
We recently bought a new car and financed it. I was able to get a loan for 1.49% so I knew I would be able to earn more investing the car money compared to what I will end up paying in interest.
Great tips. It helps to get a good auto loan that suits your financial capability. There are many things to consider before buying a car — most car buyers forget to include maintenance costs in their budget and it becomes difficult.