Car Buying Tips

How Much Should You Pay for a Car Based on Your Income?

By TheCarzingTeam August 18, 2022 | Car Buying Tips

Car Buying Tips

When choosing the best car, many buyers are forced to consider the price tag. In many cases, the budget impacts the vehicle choice. First-time buyers might not know how to determine their ideal car price, but reviewing the budget can help buyers discover how much car they can afford.

How much should you pay for a car based on your income? Experts have opinions on how to determine the best price for a car according to income. When using income to help determine the best vehicle budget, buyers need to focus on their take-home pay; this is the amount that’s left after taxes and other costs (like healthcare) are deducted from the paycheck.

Typically, experts recommend buyers spend:

  • Less than 10 percent of take-home pay on a car payment
  • Less than 20 percent of take home pay for total vehicle expenses (i.e. the car payment, insurance, fuel, repairs)

However, some experts recommend that total expenses should be less than 10 to 15 percent of take-home pay. These recommendations might take into account that the individual’s income needs to also be able to accommodate larger bills like housing that tend to account for more of the monthly expenditures.

Income Isn’t the Only Factor that Buyers Need to Consider

Other factors impact the amount an individual can spend on a car, too. In addition to reviewing monthly income, buyers also should consider:

  • Down payment amounts
  • Credit score
  • Trade-in value

Down Payments Can Lower the Car Price and/or Decrease Loan Terms

Down payments can play a crucial role in the car purchase price. Experts recommend allocating a 20 percent down payment for a new car and a 10 percent down payment on a used car.

The recommended amounts can help decrease the impact of depreciation. A car could depreciate around nine to 11 percent just driving off the lot. If a buyer doesn’t make a large enough down payment, the car could be underwater immediately. This means that the value of the vehicle is less than the outstanding loan balance.

However, down payments also help decrease the cost of the car. A buyer that has saved up a significant amount of money for a down payment might be able to buy a more expensive car as the down payment lowers the price (and the monthly payments).

Other buyers want to pay off their car as quickly as possible. They may come to the dealership with a larger than expected down payment. This could help them choose a shorter loan term.

Some allocate that larger down payment to help them afford a more expensive vehicle (while still offsetting the depreciation). Down payment amounts can help buyers lower their purchase price, choose shorter loans or maybe even opt for a nicer car.

How Much Should You Pay for a Car Based on Your Income

The Credit Score Can Impact the Loan Options

How much a buyer can spend on a car could change because of the loan terms they are offered. Before visiting a car dealership, buyers should review their credit report. Consumers can receive a free credit report every 12 months.

Reviewing a credit report can help buyers understand their creditworthiness or their credit risk. Scores depicted on free reports won’t be exact numbers that lenders receive, but the scores should be close enough to use as a reference point.

Buyers also could notice an error on their report that impacts the score. When buyers notice issues with their report, they can take action to help correct it.

A credit score might be on the low end. When buyers see that their score is low, they might begin to take action to help improve their score. There are a number of factors that impact a credit score, but the most influential factor is the individual’s payment history. This makes up 35 percent of a credit score.

Making late payments consistently can ding the credit score. If individuals aren’t making timely payments, they might want to set reminders on their phone to alert them to pay bills on time.

Those who need a car immediately and have a low score might face higher interest rates from lenders. However, if scores are extremely low, they also could be denied a loan.

If a credit score is high, buyers might be in a great place for finding loans with lower rates. They can shop around to find the best options. While a high interest rate might mean that the buyer can buy less car for their money, those with high scores might be able to have a lower monthly payment on a more expensive car.

However, while low interest rates can help buyers focus on their principal, they still need to stick to their budget. Buyers should review their budget to better understand how much they can allocate per month towards their car payment.

How Much Should You Pay for a Car Based on Your Income

Trade-In Values Can Help Decrease the Purchase Price, Too

Buyers who have a trade-in to offer at the dealership could use the value of that vehicle to help decrease the cost of their new car. The trade-in can help make the vehicle more affordable and perhaps lower the monthly payments, too.

Know the trade-in value of a vehicle before visiting the dealership, though. Use Kelley Blue Book (KBB) to receive a trade-in estimate for the car. KBB will ask the owner to either enter the make/model or the VIN or license plate information.

The next step in the process is to choose the trim of the model. Car owners also will need to choose any applicable upgraded features that are included in their vehicle. They also can select the base trim (if there are no upgrades). Buyers also need to note the condition of their vehicle.

Dealerships will be able to tell between a car that is in excellent condition and one that is just in fair condition. Bringing in an inflated estimate based on a condition that isn’t accurate won’t help negotiations, so buyers need to be honest about the vehicle’s condition when using KBB to research prices.

When buyers receive their estimate from KBB, they can use this information as a reference at the dealership. If the buyer feels that the dealership is coming in too low with a trade-in value, they can reference their info from KBB.

A trade-in combined with a decent down payment can make an impact on the purchase price of the vehicle. Buyers could lower their monthly payments or even choose a shorter loan term.

Some Buyers Also Prefer to Pay in Cash

While experts recommend keeping monthly payments to less than 10 percent of take-home pay, some buyers might have a different financial comfort zone when they buy a car. Not all buyers want to finance their car; some simply want to pay in cash and not accrue monthly debt.

These buyers could save up for a new car or they might choose a used car. For the cash buyer, the money in their hand is the budget.

However, buying a car outright means that the car’s value is equity for the owner. In addition, the buyer doesn’t have to worry about a monthly payment. However, they do need to account for insurance and other costs of the vehicle.

How Much Should You Pay for a Car Based on Your Income

When Budgeting, Don’t Forget These Car Expenses

Buying a car might mean that the consumer focuses only on the monthly payment. While the monthly cost of the vehicle needs to be affordable and in the budget, buyers cannot forget that they also are responsible for other expenses, too.

In some states, buyers don’t need to pay sales tax on car purchases. In states where these taxes are applicable, though, not all buyers may be able to add them to a car loan. This would mean that the buyer is responsible for paying sales tax in full and out-of-pocket.

Before beginning a new car hunt, buyers also should research the tax guidelines in their state. Try to prepare for these costs when shopping for the vehicle. When buyers are prepared, the bill won’t be a shock at the DMV.

In addition, buyers also will need to pay for any registration fees for their new vehicle. Most importantly, they need to be sure that the vehicle is insured before even driving it off the lot. Some insurance companies have grace periods, but the buyer is responsible for understanding their insurance policy. Call the company and find out what’s needed to insure the new vehicle.

Why Buyers Might Need to Spend Much Less than 10 Percent of their Pay

The ‘less than 10 percent of take-home pay’ recommendation might be a good guideline to follow, but some buyers might discover that they are on a much tighter budget. Major expenses like medical bills, health insurance and student loans can encroach on disposable income.

Some buyers might have very little left over each month to spend on their car payment. Buyers who feel crunched could look at used cars to purchase outright. In addition, leasing a vehicle could be a more affordable option.

While expert recommendations for car expenses could be a good reference point for new buyers, ultimately, the individual budget plays a decisive role in determining the best monthly payment for a new car.

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