How Much Car Can I Afford?
There are few things that are more exciting than shopping for a new car. Touring showrooms, taking test drives, and customizing vehicles can be exhilarating. Unfortunately, many people get caught up in the excitement of the experience and end up spending far more than they can afford.
Buying a new or used car is most likely one of the biggest financial commitments you will make in your lifetime, so it’s important to do your homework. One of the first questions you should ask yourself is, “How much car can I afford?” Here’s what you can do to answer this question:
Follow the Golden Rules
There are a number of so-called “golden rules” that experts recommend following when determining how much you can afford to spend on a new car.
Many experts recommend the 10-15% rule. This rule states that if you purchase a new car, your monthly car payment should not exceed 15% of your monthly income. If you purchase a used car, however, the payment should not exceed 10% of your monthly income. Once you calculate how much you can afford to pay per month, you can work backwards to figure out how much you should spend on your new or used vehicle.
Other experts recommend following the 20% rule, which states that all car expenses should not exceed 20% of your monthly income. This includes your monthly car payment, gas, insurance, maintenance, and all other expenses related to owning a vehicle.
Finally, there is the 35% rule. This rule states that regardless of whether you are buying a new or used vehicle, the price of the vehicle should not exceed 35% of your annual income. So if you make $40,000 per year, this means you should not purchase a car that is more than $14,000.
These golden rules may not work well for everyone, but they are a good place to start if you aren’t sure how much you should spend on a new or used vehicle.
Use A Free Car Affordability Calculator
You should take advantage of all the tools at your disposal, including the countless free car affordability calculators that are available online.
You will need to provide some basic information to estimate how much you can afford to pay for a new or used car using these calculators. Each calculator may rely on a slightly different formula to calculate how much you can afford.
For example, some calculators may factor in your credit score whereas others may not. But in general, be prepared to provide:
- Your ideal monthly payment
- Your ideal loan term
- Credit score range
- Down payment amount
- Trade-in value, if applicable
- Your location
Once you enter this information, the tool will calculate how much you can afford to spend on a new or used vehicle. Some tools will give you an exact number, whereas others will give you a price range. For example, one tool may tell you that you can afford to spend up to $15,000 on a new vehicle, whereas another may say you can afford to spend between $13,000 to $15,000.
Because each tool may use a unique formula, it’s best to get estimates from several different calculators when setting your budget. It only takes a few minutes to use these tools, so this is a quick and easy way to get an idea of how much you should spend.
Keep These Key Factors in Mind
A number of factors can impact how much you can afford to spend on a new or used car. If you are trying to set a budget for your next vehicle purchase, it’s important to keep these key factors in mind:
- Your credit score: Unless you are paying in cash, your credit score will impact how much you can afford to spend on a car. This is because your credit score will affect the interest rate on your loan. The higher the interest rate, the higher your monthly payment.
- Your debt-to-income ratio: Lenders will evaluate your debt-to-income ratio when determining your eligibility for an auto loan. Most lenders will not approve an applicant with a debt-to-income ratio that is greater than 50%.
- Your down payment: Some people use cash as a down payment, whereas others use their trade-in vehicle as a down payment instead. Regardless of which option you choose, it’s important to know how much you will be putting toward the purchase of your new or used car. This will impact how much you need to borrow and how much you can afford to spend.
These are some of the many factors you should keep in mind when determining how much you can afford to pay for a new or used vehicle.
Don’t Forget About Extra Expenses
Your auto loan payment is the biggest monthly expense you will incur if you choose to buy a new or used car. However, it’s not the only expense associated with vehicle ownership. If you want an accurate calculation of how much you can afford to spend, it’s important to consider other costs you will incur when you own a vehicle.
For example, unless you are buying an electric vehicle, you will need to factor in the cost of gas when determining how much you should spend on a car. Regardless of the type of vehicle you purchase, you will need to consider the cost of insurance, maintenance, and repairs.
These costs can vary on a case-by-case basis, however, AAA estimates that the average monthly vehicle ownership expenses are:
- Gas: 10.72 cents per mile
- Maintenance and repairs: 9.55 cents per mile
- Insurance: $100 per month
- License, registration, taxes, and other miscellaneous expenses: $63 per month
You will need to be able to pay your monthly payment in addition to all of these expenses, so don’t forget to include them in your calculations.
Getting pre-qualified for an auto loan is another way to figure out how much you can afford to spend on a new or used vehicle. If you apply for pre-qualification, the lender will tell you how much you are eligible to borrow based on the information you provided. This way, you know what type of vehicle you can afford to purchase once you start shopping.
It’s important to note that getting pre-qualified is not the same as getting pre-approved for an auto loan. A pre-qualification is based solely on general information you provide about your finances to the lender.
The lender typically does not verify the financial information you provide during the pre-qualification process. Make sure the information you provide is accurate. If it’s not, the terms of your pre-qualification may change once your lender updates your quote with accurate information.
If you apply for pre-approval, however, the lender will ask for more detailed information about your income and debts. The lender may also independently verify that the information you provided is accurate before giving you a pre-approval letter. Because of this, the terms of a pre-approval are usually more accurate than the terms of a pre-qualification.
Fortunately, getting pre-approved or pre-qualified for an auto loan isn’t hard. In fact, many lenders allow you to complete this process online in a matter of minutes.
Follow these tips to ensure you know how much you can spend before you start car shopping. This way, you won’t end up buying a new or used car that you cannot afford.