How Much Car Can You Afford?

By David Ning on 25 June 2012 (Updated 3 June 2014) 6 comments

If you are interested in buying a car and you are set on leasing, it is very important that you maintain a good balance between the type of ride you desire and your ability to finance it. Remember that even though you may qualify for a car loan, burdening yourself with one that is beyond your payment ability can easily destabilize your financial status. To rightly determine what you can afford, it is important to create a budget. Here are some things to keep in mind when creating said budget. (See also: Guide to Buying a Used Car Without Going Crazy)

The 20% Rule of Thumb

The general rule on car payments is that they should not exceed 20% of your take-home or net monthly income. This value is inclusive of car insurance, repairs, and monthly payments. The value should also include every vehicle you own. Even if you do not take care of other major monthly expenses such as rent, you should still stick to the rule. Obviously, if you will be making a full cash payment for your new car, you will not need to apply the 20% rule. But the rest of you, take note.

Your Interest Rate Matters

Your credit rating will help determine the interest rate you will be required to pay. If you have a poor credit rating, you will most likely end up paying a higher interest rate than someone with a good credit rating. It is important that you factor your loan's interest rate into your budget, so that you can choose a car that truly matches with what you can afford. Different times of the year also have different market interest rates. If rates are lower, your monthly payment will be reduced, and you might be able to afford a car with a higher value than you initially thought (as long as it is still within your budget). This is also one reason why so many people talk about trying to achieve a perfect credit score.

You Should Make a Down Payment

Not so long ago, customers were required to make a down payment before getting a car. Today, however, many car dealers are willing to offer cars even with no down payment. In spite of this change, it will work out best for you if you make a substantial down payment, since you will be able to afford a car with a better value and still stick to the 20% limit.

Once you have determined how much car you can comfortably afford, it is important that you stick to your budget when you step into the show room. This is because you will most likely find persuasive salespeople, most of whom work on commission and are therefore only interested in getting the highest pay. Most of these salesmen are least concerned about whether or not you can afford a particular car. It is therefore important that you remain adamant in the midst of all the persuasion to avoid spending money that you do not have.

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Guest's picture

I still cannot afford a new car.. :(
But I'll get there.. :)

Guest's picture

Good article. I think you should go further and discuss other options versus just purchasing a new car. For example, buying used, leasing, and car-sharing.

Guest's picture
Guest

20% of take home pay on a depreciating asset! Terrible advice.

Guest's picture

Including car payments, insurance payments, and potential repairs, 20% seems like about right. You may want to do extensive research before going into the dealership, especially because a lot of times insurance rates relate to the area where you live and drive. The insurance I pay here in Tampa, is about $100 higher per month than what my sister pays in the greater Boston area.

Guest's picture
Juggler314

20% seems awfully high, in fact I would go so far as to say this is terrible advice. Lets assume you aren't making a ton of money and your effective tax rate is 15%, you're take home on a 40k salary would be approximately 34k/12months=2833/month. 20% of that is 566/month. I make well over 40k/year and my budget for car expenses was around that - and i still felt like it was a HUGE commitment. To say nothing of the fact that the other rules of thumb for debt is that your mortgage shouldn't be more than 28% of your gross income - 28% of your gross income at an effective rate of 15% = 23.8% of your net take home. So you should be spending nearly as much on your car as your house? Another "rule of thumb" is that your total debt shouldn't exceed 36% of your total gross - so if your car is eating up around half of that...seems like a fairly unwise choice. I mean if you can afford it sure - but I think something closer to 10% is more realistic.

Guest's picture

If you have no other debts, then 20 percent for the car is all right. However, the reality of life is that most people will have other debts as well, which may include the mortgage, credit cards payments and personal loans. This is why I suggest paying nothing more than 10 percent of monthly your income for the car. While that figure may look low but when you add 30 percent for the mortgage and another 10 percent for all the other loans, the figure comes up to 50 percent!

As for me, I limit my debts – all of them – to a maximum of 40 percent of my monthly income. If this means buying a more down-to-earth car, so be it.

Anyway, why worry about cars? Next year’s model is always better!