Outside of a house, a new car is one of the most expensive purchases you’ll make in your entire life. But before you go signing documents, make sure you understand how much you can afford to reasonably pay for a vehicle.
Car Affordability Rules of Thumb
Every financial guru has their own recommended rule of thumb for how much you should spend on a car payment, how much is too much, and which financial metrics to analyze. Here are a few common ones:
- The purchase price of a vehicle should amount to no more than 35 percent of your pre-tax annual income. In other words, if you make $60,000 per year, you should spend no more than $21,000 on a vehicle. (This is one of the more lax rules of thumb.)
- The 20/4/10 Rule states that you should make a down payment of at least 20 percent, finance the vehicle for no more than four years, and not let your total monthly vehicle expenses (including principle, interest, and insurance) exceed 10 percent of your gross income.
- Financial guru Dave Ramsey is known for being super conservative in his financial advice, but he’s successful for a reason. His rule of thumb says that the total value of your vehicles should be no more than half of your annual household income. If you’re married and your household income is $80,000, this means you and your spouse should each own vehicles worth $20,000 or less ($40,000 or less combined).
Clearly, everyone has a different opinion. And at the end of the day, it’s all about being intentional with your car purchase. By making smart decisions on the front end of the purchase, you can enjoy greater financial flexibility over the life of the loan.
How to Ensure a Reasonable Monthly Car Payment
Practically speaking, here are some different ways you can increase your chances of getting a reasonable deal with friendly financing:
1. Develop a Budget
You can’t make a smart vehicle purchase if you don’t know how much money you make and what your monthly expenses are. So this is the place to begin.
Grab a sheet of paper (or budgeting app) and list every source of income and monthly expense you have. This will tell you exactly how much wiggle room you have in your budget. (It’ll also highlight any areas of excessive spending that you may need to eliminate.)
With your monthly budget established, pinpoint a reasonable limit for buying a car. This is your top number. You shouldn’t pay a penny more.
2. Find a Competitive Car Loan
The next step is to find a competitive car loan. While most car dealers will try to get you to use their in-house financing, you can almost always find a more attractive deal elsewhere. Go online and use a car loan calculator to determine the cost of a car loan based on the loan amount, purchase price, trade-in, long-term interest rate, etc.
3. Pay Some in Cash
While a car dealer may advertise zero-down deals or short-term zero percent financing, it’s almost always better to pay some cash.
A partial cash down payment lowers your monthly payment and helps you establish some upfront equity in the vehicle. This lowers your chances of ending up “underwater” on the loan in the future.
4. Take Care of Your Vehicle
The final piece of advice is to take care of your vehicle. This won’t be the last car you own, which means you’ll eventually have to trade it in. And when you do so, you want to be sure you get the maximum possible value in return.
Taking care of your vehicle means investing in preventative maintenance, regularly changing fluids, inspecting and replacing brakes and tires, and keeping the inside and outside of the car as clean as possible at all times.
Make a Smart Car Purchase
The size of your car payment shouldn’t be the only determining factor in whether or not to buy a vehicle, but it’s definitely an important one. And while every situation is different, we hope this article has provided you with a little bit of extra clarity and insight into making a smart and fiscally savvy purchase that you’ll be satisfied with for years to come.