No matter how well you take care of your car, you’ll eventually need to replace it with a newer model. If you’re like most drivers, this means you’ll be replacing a car almost every seven years.
If you’re asking yourself, “what car can I afford?” you’re not alone. The hardest part for most drivers looking to buy a car is setting a budget.
So, how much should you spend on a car if you’re looking to keep it for many years to come? Here’s what you need to know to pick a price point.
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Stick to What You’ve Saved Up
The easiest way to decide how much you should spend on a new or used car is to limit your options to what you can afford to buy with cash. Think about how much money you’ve saved up over the last few months or years.
If it’s small, you may want to put off buying a new car until you increase your savings. However, if you have a decent amount saved up, use that total to guide your budget.
Using your savings and keeping the purchase price within that amount will help you avoid having to take out a loan. This way, you won’t have to worry about making monthly payments, increasing your overall debt, or paying high interest costs over the life of the loan.
Follow the 20/4/10 Rule
Unfortunately, buying a car with cash isn’t always an option. Either the cars you want cost too much or you just don’t have enough money saved up. Whatever the reason, the 20/4/10 rule can help you figure out how much car you can afford.
The rule breaks your budget into three parts.
The first part of the rule refers to your down payment. You should have at least 20 percent of the car’s sale price saved up before you buy the car. If your trading an older car in, its trade-in value can count toward that amount.
The second part of the rule refers to the length of the loan that you’ll use to finance the rest of the purchase price. You should choose a loan that lasts for no more than four years. Financing your car with a longer-term loan means you’ll pay more in interest.
The third part of the rule refers to the percentage of your annual income that you should spend on a new car. Ideally, the amount you finance with your car loan should be no more than 10 percent of your annual income.
This rule is a general guide, but it’s been in use for decades. With the average car costing buyers more than $36,700, it can be tough to find a car that fits this rule.
Keep It Under 50 Percent of Your Annual Income
Another way to answer your question of “how much should I spend on a car” is to look at the cost as it relates to your annual income. Some personal finance experts suggest that you can spend up to 50 percent of your annual income on a new car.
This means that if you make $50,000 a year, you can reasonably afford to buy a $25,000 car. In theory, you’ll be able to afford your monthly loan payments easily by not exceeding this amount.
However, that doesn’t mean you should buy something that’s worth 50 percent of your income.
You need to think about your total existing debt and consider how much you spend on those outstanding loans before you can safely follow this rule. If you have lots of credit card debt or other personal loans outstanding, buying a car according to the 50 percent rule may put strain on your budget.
If you can’t afford the monthly payments on top of your other regular expenses, you can’t afford the car.
Payments Should Be Less Than 15 Percent of Monthly Income
If you don’t debt payments monopolizing your monthly income, consider looking for cars and car loans that have payments that are less than 15 percent of your monthly income.
For example, if you make $3,000 a month, you could afford a car loan with a payment of about $450.
If you follow this rule, you should be able to get into just about any car or mid-size SUV you want, especially if you have a 20 percent down payment.
As always, consider your other expenses before you commit to spending 15 percent of your earnings on a car payment. Things like rent, groceries, utilities, car insurance, and recurring monthly expenses should always come first.
How to Figure Out Your Budget
Now that you know the most common ways of calculating how much car you can afford, you need to create a budget. This will be different for everyone and may change throughout the year based on your salary and ongoing expenses.
Create a list of your fixed monthly payments like rent, utilities, insurance, and other such costs. Then, add up your other regular expenses that occur each month. This will give you an idea of how much you spend.
Then, look at how much money you bring in each month from your job, side gigs, or investments. Subtract your total expenses from your monthly income.
The number you have leftover is what you can afford in car expenses less any money you want to set aside for savings.
If you feel that the number is too low to get into a new car, start looking at used options. These cars typically cost far less than new models and can save you thousands without forcing you to sacrifice the features you want in your ride.
So, How Much Should You Spend on a Car? It Depends
Ultimately, the only way to answer the question, “how much should you spend on a car?” is to look at your personal finances and budget. Once you have a number in mind, you’re able to start looking at your options.
Remember, you don’t have to rush the buying process. Take your time and choose a car that fits your budget and your needs.
When you’re ready to buy, be picky about the type of loan you apply for. Get a loan that offers fair terms and affordable monthly payments.