The Car Coach: How much can you afford to spend on a car?
The first question to ask when talking about buying or leasing a new or used car is how much can you afford? This question can be answered with a simple rule of thumb: Car buyers should spend no more than 10% of their take-home pay on a car loan payment. And no more than 20% on total car expenses, which also includes things like gas, insurance, repairs, and maintenance.
Once you know the monthly car payment you can afford, you can calculate how much you can afford to borrow for your car loan. With that, you can set a realistic target price and finally answer the question, “What car can I afford?” Once you have the number that you can afford, be aware that if you tell a car salesperson I can afford X, they will just increase the length of your loan. So know how many years you want to carry that expense.
How do you determine how much car you can afford?
Calculating how much car you can afford before you visit the dealership can save you hundreds, maybe thousands, of dollars in the long run — and you won’t be putty in the hands of a car salesman. These three steps are critical to avoid being car poor.
1. Calculate the car payment you can afford
NerdWallet recommends spending no more than 10% of your take-home pay on your monthly auto loan payment. So if your after-tax pay each month is $3,000, you could afford a $300 car payment.
It’s important to be realistic about how long you can or want to be making this monthly payment. NerdWallet recommends maximum loan terms of 36 months for buying a used car and 60 months for new cars.
Taking a longer loan term will reduce your monthly payment, but over time you’ll pay much more in interest. Also, a longer loan term increases your risk of becoming upside-down on the loan, meaning you owe more than the car is worth.
2. Calculate the car loan amount you can afford
Now that you’ve calculated your affordable monthly car payment amount, you can start to get a sense of how much you can borrow. This will depend on several other factors, including:
Your credit score, which will in part determine your annual percentage rate, or APR, on the loan.
Your loan term: how many months you have to pay off the loan.
Whether you buy new or used. New car loans tend to have lower APRs.
With a monthly payment, an estimated APR and loan term, the car affordability calculator works backward to determine the total loan amount you can afford.
3. Set a target purchase price
The total loan amount you can afford isn’t necessarily the price of the car you can afford. If you’re making a down payment or trading in your old car, you’ll be able to buy a higher-priced car, or borrow less money.
Additionally, there will be sales tax and fees, so think about more than just the price on the window sticker. Once you estimate the car loan amount you can afford, and assuming no trade-in credit or down payment, you can begin to get a realistic idea of the purchase price you should consider.
You’ll need to factor in sales tax and fees, which vary by state. I discussed DEALER FEES on my channel.
An easy way to estimate these extra expenses is to add 10% to the advertised price of the car (even though you might negotiate a lower price). For example, if you see a car advertised for $20,000, you should assume your total cost — the “out the door” price — will be $22,000.
If you want to get a more precise estimate, here’s a breakdown of the typical extra costs:
Sales tax: Depends on your state, county and local taxes.
Registration fees: Estimate these fees by using your state’s department of motor vehicles site.
Documentation fee: Ranges from $50 to $400, depending on the dealer.
This means that if you can afford a $20,000 car loan, again, assuming no down payment or trade-in credit, you’ll want to shop for a car with a sticker price of around $18,000 so that you’ll be able to cover sales tax and fees with your total loan amount.
Many automotive sites, such as Car Gurus, Kelley Blue Book, Edmunds and True Car have car finder search tools to show you different models listed by price.
Remember to set the bar low. When searching for cars, set your maximum price below the total loan amount you think you can afford. Sales tax and fees can easily add up to an extra few thousand dollars.
The Bottom Line
Aim to spend less than 10% of your take-home pay on your car payment and less than 15% to 20% on car expenses overall.
More Car Smarts tips and ways to save money are in my book, Lauren Fix’s Guide to loving your car.
Don’t forget to check out our all-new website Car Coach Reports
There are more features and design information that we cover in our video review. Check out the Car Coach Reports Ratings on this video before you buy any vehicle.
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