How to Calculate How Much You Can Afford to Spend on a Car

When thinking about what you should spend on a vehicle, keep in mind that the purchase price is only one part of your expenses. 

To make sure you can comfortably afford the car you want, make sure you account for the following: 

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What we dislike about the 36% rule

As with so many car finance guidelines, there is no objective reason, why the exact number should be 36%. Sure, it’s a rule of thumb, but where does it come from? Why are 35% okay, but 37% are considered too much?

Also, if you really think about it, 36% are actually quite a lot. In the USA, these high constant levels of debt are quite normal. In the UK, they’re not and for a reason: The higher your debt level, the lower your immunity to sudden financial shocks.

Ultimately, the 36% rule is not bad. But is may just be a tad too lenient on the overall debt level.

What we like and dislike about the 20/4/10 rule

There are many laudable components to this rule. It is easy and to the point and it comes with concrete expert recommendations. If you search for the ideal loan repayment period, for example, you will find plenty of examples which suggest four years is the best time frame.

So, in many respects, this rule has its sources down straight.

On the other hand, it is not an approach that will work for most people. A 20% downpayment will stretch the limits of most people’s budgets. As will the monthly loan payments of a four year car deal.

And if your salary is very low, you will be hard pressed to find any car at all at a rate of 10%.

6. Maintenance Fees

While you may not be thinking about repairs on a new vehicle, all cars need maintenance. If your car is older, it may need a tune-up or new tires. 

In general, maintenance costs about 9 cents per mile. If you drive 12,000 miles per year, then you should expect to spend $1,080 on maintenance annually. 

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.

How Much Should I Pay?

The exact amount that you should spend on a car might change depending on who you ask. Some experts recommend that car-buyers follow the 36% rule associated with the debt-to-income ratio (DTI). Your DTI represents the percentage of your monthly gross income that’s used to pay off debts. According to the 36% rule, it isn’t wise to spend more than 36% of your income on loan payments, including car payments.

Another rule of thumb says that drivers should spend no more than 15% of their monthly take-home pay on car expenses. So under that guideline, if your net pay is $3,500 a month, it’s best to avoid spending more than $525 on car costs.

That 15% cap, however, only applies to consumers who aren’t paying off any loans besides a mortgage. Since most Americans have some other form of debt – whether it’s credit card debt or student loans that they need to pay off – that rule isn’t so useful. As a result, other financial advisors suggest that car buyers refrain from purchasing vehicles that cost more than half of their annual salaries. That means that if you’re making $50,000 a year, it isn’t a good idea to buy a car that costs more than $25,000.

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Other things to consider

There are more costs to owning a car than just the payment and insurance. You should also budget for how much you’ll need to spend on gas and maintenance — although a new car should be covered under warranty for most of a new-car loan period.

Also consider the length of your car loan. While longer loans will, in general, give you a lower monthly payment, you’ll be paying more overall in interest charges. In addition, longer loans increase the amount of time you’re “underwater” on the new car. That’s the situation, known more formally as negative equity, when you owe more on your loan than the car is worth if it was sold. And that can make it more difficult to sell or trade-in the car.

Finally, don’t forget that these guidelines can and should vary depending on your situation. If you don’t drive very much, or spend a lot of your income on housing costs, you may prefer to spend less per month on your new car. If you’re a car enthusiast, or need a very specific vehicle for your job or commute, you might want to stretch your budget a little higher. Overall for most people, spending 10% to 15% of your monthly take-home pay on a new car loan is a good guideline.

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