The affordability of a car depends on various factors, such as your monthly income, credit score, and desired features. It is generally advised by experts to allocate no more than 20 percent of your take-home pay towards owning a car. This percentage should encompass not only the cost of car payments but also expenses like fuel, insurance, and more. Balancing your vehicle needs with your budget is essential in determining affordability.
How to determine how much car you can afford
When establishing a budget for your vehicle, begin by determining the amount you can comfortably afford to pay each month. Take into consideration expenses such as maintenance, fuel, and insurance, along with loan or lease payments. Ensuring that all these costs are accounted for will help you manage your finances effectively while enjoying your vehicle.
1. Decide between leasing and buying
The choice between leasing or buying a car can greatly impact your affordability. Opting for a lease is ideal for drivers seeking lower monthly payments and the opportunity to drive the latest car models. Lease payments primarily cover the vehicle’s depreciation rather than its entire value. However, it’s important to note that a down payment is still required, and you’ll be responsible for maintaining a car that won’t ultimately be yours to own.
Purchasing a vehicle puts you securely in control, free from mileage restrictions and extra fees for wear and tear. It is true that buying a car is a more expensive upfront investment compared to leasing, and it’s crucial to consider depreciation to avoid being in a negative equity situation. However, the advantage of ownership allows you the flexibility to sell the car if necessary.
Utilize a leasing versus buying calculator to determine potential savings. The affordability factor depends on your vehicle usage plans, so it’s important to thoroughly research the advantages and disadvantages of each option before making a decision.
2. Consider your salary
The amount you earn plays a crucial role in determining the most suitable auto loan for you. According to Edmunds, when it comes to financing a new car, it is recommended that your monthly payment does not exceed 15 percent of your take-home pay. For a used car, this percentage should be no more than 10 percent, although different experts may suggest different figures.
It is important to consider additional expenses such as insurance, fuel, and other monthly costs. Ideally, the total cost, including these factors, should not surpass 20 percent of your monthly take-home pay.
Your income is also a crucial factor when seeking loan approval. Lenders evaluate your debt-to-income ratio (DTI), which compares your monthly bills to your gross monthly income. To secure a loan approval, most car dealers prefer a DTI of no more than 45 or 50 percent, as reported by The Car Connection.
Even if you have enough cash to buy your car outright, it’s important to consider your purchase within the broader context of your annual salary and expenses. Take into account the trade-off between paying in cash, which may deplete your emergency fund, and opting for manageable payments over time. This ensures a more thoughtful and financially prudent approach.
Opting for vehicle financing may not always be the wisest decision, especially if it means exceeding the recommended portion of your monthly income toward loan payments. However, for certain buyers, financing a vehicle can be a sensible choice when carefully considered within the context of their overall financial situation.
3. Factor in additional vehicle costs
When it comes to owning a car, two major expenses to consider are fuel and insurance costs. To estimate the mileage for your preferred vehicle, fueleconomy.gov can be a valuable resource. Opting for a car with excellent gas mileage not only helps you save money monthly but also maximizes potential mileage reimbursements from your employer. Prioritizing these factors will ensure a more cost-effective and efficient car ownership experience.
Insurance costs can vary based on the vehicle and the individual. Even if two cars may appear similar to you, they can be perceived differently by insurance companies. To gain insight into potential insurance costs and the factors that insurers consider when determining quotes, using a car insurance calculator is a valuable starting point.
Typically, companies evaluate various aspects, including your driving record, car usage, location, age, gender, credit, coverage type and amount, as well as the discounts you may be eligible for.
The regulations governing auto insurance pricing may vary depending on the state you reside in, with certain restrictions imposed on insurance companies.
Can you afford the car you want?
Once you have a clear understanding of your budget, you can evaluate whether the car you’ve been interested in is attainable and whether financing will be necessary. By following these steps, you can assess the affordability of a particular vehicle or loan with greater precision.
1. Know how much you’ll really pay
When considering your vehicle loan payments, it’s important to keep in mind that they encompass more than just the price of the vehicle itself. It’s crucial to be aware of the “out the door” (OTD) price, which includes not only the cost of the vehicle, but also taxes, fees, and any additional add-ons you choose to purchase.
By conducting thorough research, you can gain valuable insights into the expected state sales taxes, as well as the fees for title and vehicle registration.
While certain dealer fees are mandated by law or company policy, others may be open to negotiation or removal. Knowing which fees are up for discussion can help you save time and frustration during negotiations.
When shopping for a vehicle, keep the overall cost in mind and aim for a specific sticker price. Remember that the out-the-door (OTD) cost, which includes additional fees, will typically increase the car’s price by 10-15%, depending on your location.
2. Get an initial figure by using a car loan calculator
The interest rate you obtain on an auto loan is a significant factor in determining your monthly payment. A higher credit score will secure you a lower interest rate, resulting in a reduced monthly payment and a decrease in your total loan cost.
To determine how various interest rates will impact your monthly car payment, utilize a car loan calculator. Here’s how you can go about it:
- Obtain a copy of your credit report and familiarize yourself with your credit score.
- Get prequalified by multiple lenders to ascertain the average interest rate that may be offered to you.
- Input the interest rate, desired repayment term length, and car price into the calculator.
By following these steps, you can accurately assess the potential influence of different interest rates on your monthly car payment.
When considering a loan, the duration of the loan is an important factor to take into account. Opting for a shorter loan term may result in larger payments, but it will save you on overall interest paid. While it might be tempting to choose a longer loan term, it could be wiser to opt for a more affordable vehicle instead.
3. Use a cost-to-own tool
In addition to the monthly payment, it’s important to assess whether you have the means to sustain the vehicle. Take the time to gather a few car insurance quotes and utilize a cost-to-own tool to obtain estimates of potential expenses.
Both Edmunds and Kelley Blue Book offer cost-to-own tools that take into account anticipated fuel costs, maintenance, repairs, state fees, and average depreciation.
The bottom line
To ensure financial stability after purchasing your new vehicle, it’s crucial to be realistic about your budget. Instead of solely focusing on the monthly payment, take into account all potential expenses. Look for a car that costs no more than 20 percent of your take-home pay, allowing you to meet your expectations while still having enough funds to cover unexpected costs or changes in income.
By adopting this approach, you can find a car that aligns with your needs and provides a solid financial foundation.