Median-income families in only one major city can afford the average price Americans are paying for new cars and trucks these days.
That's the sobering result of Interest.com's 2013 Car Affordability Study, which determined how much the typical household in the nation's 25 largest cities should spend on a new vehicle.
It found that median-income car buyers in the Washington, D.C., area could afford to spend $31,940, or enough to buy a luxurious BMW X1 crossover.
But those in Tampa could afford to spend less than half that much, or only $14,516, which is enough to buy a subcompact Chevrolet Sonic.
The surprising differences we found among those cities reflect not only a significant variation in median household incomes but a wide range of tax rates and insurance costs.
The results also point to a clear, undeniable conclusion.
We spent more than $30,000 on the average new car and light truck — pickups, SUVs and vans — last year.
Yet Washington is the only city where the median-income family could truly afford to pay that much.
“What this research indicates, more than anything, is that a lot of Americans are spending too much money on their cars,” says Mike Sante, managing editor of Interest.com.
“Car costs are one of the most controllable parts of a household's budget. For example, if you live in New York City or San Francisco, you’re probably going to have to pay a lot for housing, but you don’t have to pay a lot for a car. You're better off driving something more affordable and saving or investing the difference.”
Here’s how much the median-income family in the 25 largest cities can afford to spend on a new car or truck and how much that exceeds, or falls short, of the average price of a new vehicle bought last year ($30,550).
To get a clearer picture of how much we should be spending on new cars, we created Interest.com’s Car Affordability Study. (Click here to see how much you should spend on a new car or truck.)
TrueCar.com, a California-based car pricing website, says the average purchase price of new cars and light trucks rose to $30,550 last year.
We wanted to know whether households making the median household income in each city could truly afford that.
There are a number of rules on how much you should spend on a vehicle. And we're talking about rules from financial professionals, not from people in the car business.
These rules are designed to let you know the maximum you should spend on a vehicle.
This helps ensure that you'll have money left over to pay your bills and save for the future by, for example, contributing to your 401(k) plan.
Our favorite is the 20/4/10 rule, and we used it in our study.
It says you should put down at least 20% on a vehicle, finance it for no more than four years and not let your total monthly vehicle expense (including principal, interest and insurance) exceed 10% of your gross income.
Mari Adam, president of Adam Financial Associates in Boca Raton, Fla., is one of the many certified financial planners who urge car buyers to follow the 20/4/10 rule.
"If you spend too much on a vehicle, it's going to take away from more important things." Adam says. "Often, when you see people run into money problems, part of it is that they are spending too much on vehicles."
We then gathered city-specific data on median income, auto insurance costs and vehicle sales tax rates from the most reliable sources we could find, including the U.S. Census Bureau and National Association of Insurance Commissioners.
Applying the 20/4/10 rule and Interest.com’s auto loan calculator to determine how much a family earning the median income in each city could afford to spend on a car.
The difference in median incomes among the 25 cities is substantial, running from $86,680 a year in Washington to $43,832 in Tampa.
So is the difference in sales taxes, from a high of 9.8% in Seattle and 9.5% in Chicago, to a low of zero, nada, nothing in Portland, Ore.
As a result, car buyers in Portland can afford to spend about $1,300 more than those in Chicago, even though the median income is a couple of thousand dollars a year higher in Chicago and insurance costs are virtually identical.
We assumed buyers would make a 20% down payment and finance the balance over 48 months at 4.05% — the average cost of 48-month new-car loans when the study was done. (It's fallen to 4.04% in Interest.com's latest weekly survey of major lenders.)
If you have good credit, you can probably find a better rate, maybe even qualify for a free loan from one of the automakers.
|Length of financing||Interest rate|
|60-months||4.12%||Source: Interest.com weekly survey of major lenders from Feb. 20, 2013|
The lower the rate, the more you'll be able to pay for a new car or truck and still limit your principal, interest and insurance payments to 10% of your gross income.
And even if our rule of thumb says you should spend no more than $20,000 on a vehicle, it's not the end of the world if you spend $24,000 for a vehicle you're planning to keep for a long time.
But it's going to seriously hurt your finances if you sign the dotted line for a $43,000 SUV or luxury vehicle.
"It's one of the only expenses you can really control, and if you overspend, you're going to pay the price at some point," says Adam Koos, president of Libertas Wealth Management Group in Dublin, Ohio.
"There seems to be a lot of entitlement with people thinking they deserve new cars," Koos says, "but it's short-sighted."
The problem is that most car buyers aren't thinking about their financial future when they hit the showroom.
They're caught up in how cool it would be to drive the new model they saw in a Super Bowl ad and what it will take to qualify for the auto loan.
The car companies and their dealers know how to profit from our emotions and saddle us with the biggest possible loan and a monthly payment that drains our checking account.
You won't hear anything about the 20/4/10 rule from them.
Indeed, one of the auto industry's favorite tricks to lower monthly payments and help customers buy more expensive cars than they can really afford is to push longer loans.
Experian, one of the major credit reporting agencies, says nearly six out of every 10 new-car loans are now five years or longer.
The 48-month loans we recommend are bad enough, siphoning thousands of dollars in interest from your savings to pay for something that's losing value every day you own it.
Longer loans are just bigger wealth killers.
Bill Hammer Jr., president of Hammer Wealth Group in Melville, N.Y., recommends borrowing much less than you can qualify for and banking the difference.
Instead of committing to a $600 monthly payment, buy what you can get for $300 and save the rest.
Over the course of a four-year car loan, you'll have stashed an extra $14,400 in the bank.
"Put it in an emergency fund or invest it," Hammer says. "If you can take a couple hundred dollars per month and save it instead, it can make a big difference in your life."
It's how you build the kind of financial security that Interest.com is all about.
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