How Much Should You Spend On A Car?

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Point of Interest

It can be difficult to answer the question of “how much should I spend on a car,” but using a combination of tools, like the 20/4/10 rule and an auto loan calculator, can help. The guide below will walk you through the process of utilizing these tools to determine what average car payments and car price makes sense for your finances.

Most Americans are spending far more than they can afford on cars and trucks. Just because the monthly payments are manageable doesn’t mean it’s smart to let a $30,000 or $40,000 auto loan gobble up a huge chunk of your paycheck every month. This is one of life’s biggest expenses, and it’s a purchase where you have total control over how much you spend.

The car companies know this.

It’s why they devote billions of dollars a year to advertising that tries to make this a purely emotional choice. You’re urged to choose a ride that tells the world how successful you’ve been. Or how hip you are. The automakers want to grab as much of your money as you’ll let them take. Week after week. Month after month. Year after year. They want you to keep paying them.

How Much Car Can You Afford?

Instead of thinking in terms of “how much car can I afford,” try switching to “how much should I pay for a car.” The difference is in the savings.You can get a great car for much less and use the savings to invest in yourself. Here’s where the money for your retirement or kids’ college can come from.

The 20/4/10 rule

It all starts with what we call the 20/4/10 rule, which says you should:

  • Make a down payment of at least 20%.
  • Finance a car 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.

So, grab your pay stubs and determine your household’s monthly gross income. Gross income is how much you and your spouse make before any taxes or expenses are deducted.

Then, find your most recent auto insurance bills and figure out how much you’re spending per month on premiums. Take 10% of your gross monthly income, and subtract the monthly insurance premiums. That is the monthly car payment you can afford to make.

Let’s say, for example, you earn $63,030 and spend $129 a month for insurance, which is the national median household income, followed by the average premium for a single car. Your monthly gross income would be $5,252.50, and one-tenth of that would be $525.25, which means that the monthly car payment you can afford would be $396.25.

Now go to our auto loan calculator.

Click the circle at the top that says you want to calculate the “Total purchase price.” Enter the monthly payment you can afford, and choose to finance the balance over 48 months, as the 20/4/10 rule suggests. Use 5.66% for the interest rate, which is the average interest rate for a 4-year new car loan if the buyer has a “good” credit score between 700 and 749.

Or search Bankrate’s database of the best car loans rates in your area and use that rate instead.

What you’ll pay

Most buyers with reasonable credit will pay less than average for financing.

Under Down payment, on our auto calculator, enter how much cash you’ll be devoting to the purchase and the trade-in value of your existing car or truck.

Under taxes and fees, enter the sales tax rate for where you live and license your vehicles. Remember that the sales tax rate on vehicles may be different than it is for everyday expenses such as food and clothes.

Hit the “calculate” button and the total purchase price will appear at the top of the calculator. That’s the answer to “what car can I afford.”

Using our example, with a $396.25 monthly payment, $3,000 down payment, a sales tax rate of 7%, and no other fees, this family could afford to spend $19,257.

Are there situations where you could responsibly spend more?

Absolutely. Let’s say the new car or truck you’re buying offers a $1,500 rebate that you used to boost your down payment. If you have decent credit, you might qualify for discount financing from the automaker or a regular loan that costs less than the 4.14% average.

The more you put down, and the lower the interest rate, the more you’ll be able to afford to spend, but be careful. Longer loans are one of the auto industry’s favorite tricks to lower monthly payments and help customers buy more expensive cars than they can really afford.

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 wealth killers. If you need to finance a vehicle for six years, it’s a sign you can’t afford it.

The final word

When trying to figure out how much to spend on a car, remember that it may be tempting to go beyond what is reasonable. Following the 20/4/10 rule can help you mitigate the financial pain of buying a new car, but only if you stick to it. This means keeping your average car payment — including insurance — at or below 10% of your gross income, making sure not to take out an auto loan with terms longer than four years and only buying a car if you can afford 20% of its price as a down payment.

Joshua Cox-Steib

Contributing Writer

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