How Much Car Can You Afford?
Figuring out how much you can spend on a car
Shopping for a car can be an awesome experience, but before you head out and take that dream car for a spin, you should figure out how much you can realistically budget for your payments.
There are several determining factors that go into this decision. Ideally, you'll want to strike a balance between the things you want in a vehicle—say, a car that's reliable, big enough for the whole family, and low in mileage—and the price of the car.
Start with your budget
When determining how much car you can afford, the best place to start is with your monthly budget. There are a number of ways to determine your monthly budget, but some financial advisors suggest keeping your debts—including mortgage/rent, school loans, and monthly car payment for example—under 36% of your gross income (income before any taxes or deductions are taken out). Using that guideline, if you spend 28% on a mortgage then you’re left with 8% for all other debts including your auto payment. Please remember that this is an overly simplified guide, but you should think about your monthly expenses, your savings and your income to get a full picture of your financial situation.
Figure out your monthly payment range
A common mistake that car buyers make is to go for a car that’s at the highest end of their price range. You may be able to afford it on paper, but it could stretch your budget to the max and leave you little wiggle room for the unexpected expenses life throws at you.
Many factors affect the amount of a car payment, but we’ll look at only a few common ones you should consider when deciding what you can afford to pay.
The amount of cash your using for a down payment directly affects the amount you’ll owe in monthly car payments. The larger the down payment, the smaller your monthly expense will be because the less principal (or borrowed money) you'll have to pay off later. A down payment can also lead to a lower interest rate depending on the amount and your specific situation.
Your interest rate also affects your monthly payment. The higher the interest rate, the more you'll pay over the life of the loan. Car Buyers with good credit scores and a higher down payment are more likely to be offered a lower interest rate. Speak to lenders for more specifics about their individual policies.
The term of the loan is how long you’ll be making payments, which can impact your monthly payment. Typically, the longer the term, the more you'll pay in total because you’ll be paying more interest over the life of the loan. With a shorter term, you’ll pay less in interest over the life of your loan but your monthly payment likely will be higher.
Don’t forget sales tax, registration fees and insurance
It’s also important to think about the registration fees and sales taxes that don't appear on the sticker price. These can add up and bump your out-of-pocket expenses, so be sure to estimate what they'll be before you hit the dealership. Call in advance and find out the details. The Federal Trade Commission has some great resources that can help car buyers get an unbiased assessment on what they can afford.
Insurance is another cost to factor in. Different vehicles cost more to insure, depending on factors like make, model, condition, age, and type (SUV vs. sedan, etc.). Your insurance company can give you an estimate of how much it will cost for certain vehicles.
Start your car shopping by asking yourself how much car you can afford so you’re prepared to make responsible decisions about how high you're willing to go on price—all before setting foot inside a dealership. Put yourself in the driver’s seat with your finances.