“How much car can I afford?” is question # 1 before visiting a showroom or surfing the internet.
But easy to answer? Not so much – especially with an average car price of $ 38,000 according to the Kelley Blue Book. Sip.
Rule of thumb advice on how much car you can afford is everywhere. It’s typical to hear this:
- You shouldn’t spend more than 20% of your deductible on all car expenses.
- Your deposit should be 20% of the vehicle value.
A car affordability calculator helps you work out scenarios based on down payment, trade-in value, and loan amount.
Advice from financial experts
Financial advisors caution against relying on these tools alone, which don’t take into account things like auto insurance, your creditworthiness, and the funds you have access to.
“I generally think these rules of thumb often lead to more spending in the long run,” says H. Jude Boudreaux, a certified financial planner from New Orleans who learned a thing or two from a father who ran a dealership.
Patricia D. Hausknost, a certified financial planner based in Long Beach, California, agrees that current guidelines only go so far. She jokes that she says “it depends” after every question she asks about buying a car – but it’s an answer that she sticks to.
“That depends on your personal financial situation. You really need to look at your own situation and find out, ‘What can I do and what’s best for me?’ “
7 questions to ask yourself when wondering what to spend on a car
With apologies to everyone who wants to take a test drive now and ask questions later, here are seven questions financial advisors recommend asking yourself before deciding how much car you can afford
1. What controls my car decision?
Is it time to replace your “beater” with another car that you can drive into the ground? Do you need something more reliable for the cold weather you just moved into? Or do you want to buy something more economical?
Knowing why you are buying a new car will bring other decisions like new or used cars, leasing or loans into focus.
And don’t forget to think about the future, says Hausknost.
“How has your life changed and is it likely to stay that way for the foreseeable future?” For example, the pandemic shift towards work from home could shift your priorities on car payment. A growing family or imminent retirement are typical considerations.
But enough with the boring practical things. What if you just love that new car smell and want a change? That’s fine, make sure you move on to the next questions. If the math works, do it!
2. Do I have my cash flow under control?
Crack the numbers. Know what you put in (income) and what you spend (expenses). Hopefully there will be money left over for a new car. This information will guide you through the next few questions as you think about your monthly payment, loan term, and other factors.
3. What can I bring to the negotiating table?
With cash on hand, you know how much you’re willing to part with. Do you have enough to prepay for a decent used car? Would you prefer to make a substantial down payment for a new vehicle? Remember, prepayment can help you negotiate a discount, says Boudreaux.
If you have a trade-in, use an online appraiser like the one from Kelley Blue Book to work out value before bargaining.
4. How Much Debt Can I Handle?
These rules of thumb that we mentioned? When you think of a car loan they are a starting point. Bob DiDonato, a consultant at Ameriprise Financial Services in Brookfield, Wisconsin, uses these two:
- The value of a car should not be more than a third of your gross annual income.
- The car loan installments shouldn’t be more than 10% of your monthly salary.
“It’s a stomach check,” says DiDonato. “Ultimately, the situation is different for everyone.”
Are these guidelines a stretch for you or can you stretch the guidelines? To find out, DiDonato and others are asking their car buyers to:
- Any other debt you have.
- Your cash flow (see question # 2).
- Expected expenses threaten.
- How much cash you have in an emergency fund.
- Your creditworthiness, which determines the interest rate on your loan.
The better your credit, the better the terms on your auto loan – and save you money. If you have no credit or a low score, it may be worth it to get a higher interest rate to build credit or improve your score.
Boudreaux picked up on this tip while watching his father sell his car: don’t just think about your monthly payment for the car.
“This is a very deceptive number because there are many ways for traders to structure a transaction that will lead you to that number.” His advice is to negotiate the price first, and then negotiate the terms.
DiDonato adds one last question: “The really big question is, what debt are you emotionally comfortable with?” If your car debt is keeping you up at night, it is probably time to recalculate.
5. What are the “hidden” car costs?
What new or increased expenses come with your new car? That’s on DiDonato’s hit parade of car sales. And don’t be surprised by add-ons when buying. Here’s what you can get to grips with:
- Car insurance Prices. Whether new, used or leased, the premiums for your new car can be higher than what you are paying now. Call your agent or visit an auto insurance website to find out.
- Maintenance costs. Google some typical maintenance costs for the car you are considering (Kelley Blue Book has an estimator). Some cars require more expensive types of oil and fuel. The EPA has a website that allows you to research fuel costs for specific vehicles by make, model, and year.
- Sales tax and fees. These vary depending on the state. You can do the research on your state automotive website or add 10% to the car price for a ballpark.
- State fees related to titles, licensing and registration. These vary depending on the state and type of transaction.
6. Have I considered alternatives to a brand new car?
The more flexible you are in choosing your car, the more likely you are to meet your spending goal. “The hardest part is not being emotionally attached to a car,” says Boudreaux. You save money when you consider options like used and leased vehicles. Along with your answers to question no. 1, counselors offer these considerations.
When buying a leasing vehicle:
- With leasing you can get more car for your money because the leasing rate “will be relatively low in relation to the value of the car,” says Hausknost.
- What does the maintenance plan look like? Some leases include service contracts that can save you money and hassle.
- Most car leases are based on 12,000 miles per year with additional fees charged if you exceed the limit.
- If you plan to drive a car for many years or if you don’t want a monthly payment forever, this may not be for you.
- Remember: after the car lease expires, you have the option to buy at a price specified in your contract. If this is your contemplation, do your research to make sure the price is fair.
When buying a used car:
- A used car depreciates faster, which means less value if you choose to sell it or trade it in.
- You will likely have more maintenance costs. Consider extending the warranty if you want to avoid surprises.
- Previously leased cars can be a good deal, especially if you shop around.
- When it comes to financing, a used car tends to mean a higher interest rate. But the lower cost means your down payment can also be lower.
7. Final check: am I realistic?
It is a common mistake made by car buyers to unrealistically judge the impact of monthly car payments or cash expenditures, says DiDonato.
“In most scenarios, some analysis needs to be done,” he says. How much car you can afford “cannot just be a decision made overnight”.
It can be helpful to discuss things with a trusted friend, family member, or financial advisor. Think about other goals you have, such as: B. Saving for a home, vacation, retirement, or a child’s education.
Are these goals hindered by your monthly auto payment? And make sure you have a clear picture of your job security and spending habits.
“A new car is a very emotional decision,” says Hausknost. “Let your head guide you and not your heart!”
Diane M. Bacha is a writer, editor, and communications specialist based in Wisconsin with experience in newspapers, magazines, books, websites, and nonprofits. She is a contributor to The Penny Hoarder.