Buying a car, whether it’s a brand-new model or previously owned, is both exciting and potentially stressful. A car is a big purchase and it’s important to make the right decision, both in terms of the vehicle itself and how much you’ll be paying for it.
We hear from a lot of current and potential members who have questions about car loans. Specifically, they want to know how much they can afford to borrow. They might have a car in mind, but some people approach buying a car the same way they would buying a home. They want to go into it with an idea of what they can reasonably afford.
With that in mind, in this post we’ll review what you need to know about the parameters of auto loans and also link you to an auto loan calculator to help you determine the right loan amount for your next car.
Your Auto Loan vs. Your Income
There are two ways to approach calculating what you can afford to spend on a car. The first is relatively simple and has to do with your annual gross income. The second breaks down auto-related expenses as a percentage of your monthly expenses.
Let’s start with the auto purchase price as a percentage of your annual gross income. While experts may recommend spending between 10% and 50% of your gross income on a car, we recognize that’s a broad range. As such, it may not be helpful.
We recommend spending no more than 35% of your gross income on a car. By that, we mean that your total purchase price should be less than 35% of your income. If you earn a salary of $50,000, that would mean you could spend up to $17,500 on a car.
The second method involves a little more math. Basically, it says that you should spend no more than 20% of your monthly take-home pay on auto-related expenses. That means that you’ll need to consider:
- Your auto loan payment
- Auto insurance
- Maintenance and repairs
Some of these things are predictable, but it can be virtually impossible to know whether your car will, at some point, require extensive repairs. That’s why it’s important to be realistic so you don’t end up in financial stress because you spent too much.
If your take-home pay was $3,000 per month, you would be able to spend approximately $580 a month on your car. Ideally, you’d want your auto loan to be no more than 60% of that amount to ensure you have enough to pay your other expenses.
While we feel the guidelines we’ve just provided are good ones, we would be remiss if we didn’t mention there are other considerations to keep in mind before you decide how much to spend on your next car.
The 20% rule may be sufficient for some people. However, it’s essential to look at your other monthly expenses. Ideally, you shouldn’t be paying more than 30% of your gross monthly income on rent or mortgage payments. However, it’s not uncommon for people to be overextended in that regard. If that applies to you, you’ll need to make sure you’re not taking on a payment you won’t be able to accommodate.
The same is true of other expenses. You might have several children who attend a private school – or who have extensive activities that come with a price tag attached. You might have an extra-long commute to work that makes your gas bill higher than average.
The best way to decide how large an auto loan you can afford is to be realistic about your current financial obligations. It’s not a good idea to spend everything you make. Be conservative with your estimates and you won’t overdo it.
Auto Loan Calculator
Once you’ve reviewed your finances, you can use an auto loan calculator to help you crunch the numbers and go into your automobile purchase armed with the facts. After all, you want to make a wise decision that will allow you to buy the car you need without putting yourself into financial difficulty.
You can find an easy-to-use auto loan calculator here. To use it, you’ll need to know:
- The highest monthly payment you can afford
- Down payment
- Trade-in value
- Loan term
- Interest rate
Enter the information requested and you’ll get an estimate of how much car you can afford given your monthly budget. Then, you can compare that with your monthly income and expenses to figure out if you can afford the car in question.
When you’re buying a new car, you want to be realistic about what you can afford – and what you can’t. At Addition Financial, we provide an array of auto loan options that can allow you to get the car you want without busting your monthly budget.
To learn more about our auto loans or begin the application process, please click here.