How Much Should You Spend on a Car?

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Point of Interest

If you’re trying to determine how much to spend on a car purchase, these five rules will help you calculate a budget based on your current financial situation.

It can be challenging to try and answer the question: “How much should I spend on my car?” You may be tempted to ride in style in something fast and furious — which will likely come with a huge price tag. Or, you may be trying to find the most affordable option while whispering to yourself about “fiscal responsibility.” Luckily, you can find a happy medium between the two — you just have to know how to do it.

Bridging the gap between practical and impractical starts well before you head to the dealership. Without a firm understanding of how much you should spend on a car, you may be setting yourself up for getting talked into a vehicle that’s well outside your budget and miles away from what counts as fiscally responsible.

Rules to consider when buying a car

There are several different schools of thought when it comes to how much you should spend on a car. Every person’s financial situation and car-buying goals are unique, which means the approaches and rules to consider when buying a car may change based on your personal situation.

Generally speaking, though, there are five rules to consider when buying a car. Take the time to find the rule that best fits your situation, as each rule is designed to be used independently.

Tip: Before approaching the car-buying rules, figure out what your monthly and annual gross income (before taxes) is. Additionally, calculate all of your monthly debt obligations. 

Rule #1: The 36% rule

If you’ve ever looked into buying a house before, you’ve probably heard of the 36% rule. Working backward, the rule also applies to car buying. The 36% rule states that you should never spend more than 36% of your gross income (before taxes) on all your debts combined. In other words, all of your monthly debt combined (house, car, credit cards, student loans, etc.) should not be more than 36% of your pre-tax earnings.

For example, let’s say that you make $5,000 before taxes every month. Let’s also say that your only debts are your house payment and your student loan that total $1,400 monthly. Well, 36% of $5,000 is $1,800. This means that following the 36% rule, you can spend up to $400 on your monthly car payment.

Rule #2: The 15% rule

For car shoppers who are more frugal and are looking to contribute aggressively to savings, the 36% rule might be a bad fit. The opposite side of the spectrum is the 15% rule. The 15% car-buying rule operates just like the 36% rule, except that the number you are looking to stay under is 15% of your gross monthly income.

So, if you revisit the prior example where you make $5,000 monthly, 15% is $750. To find out what you can spend monthly, you’d add up all your debts and subtract that number from $750. As you can see, this rule works best for aggressively frugal spenders.

Rule #3: The 20% rule

If the 36% rule seems too aggressive but the 15% rule seems too frugal, there is a middle ground. The 20% rule operates like both of the other rules, but the percentage you are using is 20%.

Looking at the same example, 20% of $5,000 is $1,000. Add up all of your existing and future expected debts and then subtract that number from $1,000. The remaining number is how much you can spend monthly on a car payment under the 20% rule.

Rule #4: The 20/4/10 rule

A popular car-buying affordability rule is the 20/4/10 rule. While the rule takes a few more calculations, the results are clear as to what you can afford. According to the rule, you should only buy a car when you can make a 20% down payment, are financing the car for four years or less and the total cost of your monthly vehicle expenses (including insurance) does not exceed 10% of your gross income.

What’s nice about this rule is that it considers the total amount you will spend over the life of the loan while ensuring you are putting down a healthy down payment. The drawback is that the rule does not look at your other debt obligations. You could theoretically be able to afford a car under this rule but might not be in a smart position to buy based on your other outstanding debts.

Rule #5: Half your annual salary

Some financial experts recommend setting your car-buying budget at half of your annual salary. If you look at the previous example of making $5,000 monthly, that will equate to an annual salary of $60,000. Half of that is $30,000. According to this rule, you can spend up to $30,000 on your upcoming car purchase.

While this may be a good benchmark to start with, it does not take into account your current debt obligations, financing costs or what you have saved for a down payment. You might be able to use this rule in conjunction with one of the other car-buying rules to paint a more complete picture of what you can afford.

Buy vs. leasing a car

BuyingLeasing
No limit on mileageLimitations on annual mileage
Building an assetYou don’t own the car
Overall cost is higherLess expensive overall
May have upfront feesMay have upfront and backend fees
Not required to fix damagesMust pay for all damages

How to get started

  • Determine the main goal you have for buying a car. Are you looking for something flashy, something to get you from point A to B or something in between? Will you be using the car for work with clients?
  • Use the car-buying rules to determine a range of what you can afford.
  • Begin looking at the different types of cars that fall into the price bracket you’ve determined.
  • Consider all of the additional costs that come with each type of car. Is insurance more expensive? Gas mileage? Maintenance upkeep? Warranties?

How much car can you afford?

The first step to determine how much car you can afford is to collect your financial information on income and current debts. From there, plug the numbers into the car-buying rule that fits you best, and see what you can afford. After this, run the results through a car-buying calculator to see the total loan cost, monthly payments and other financial considerations. If you’re likely financing your car, compare auto loan rates to make sure that you’re getting the best deal.

Remember, at the end of the day, these are not hard and fast rules. You need to be happy with the amount you are spending and what your monthly debt obligation will be.

Tip: If the monthly car loan costs ever get too high or your financial situation changes, you always have the option of refinancing to try and lower your payments.

The final word

You can protect yourself from overspending by figuring out what you can afford before you start shopping for a car. Most car dealers are commission-based, which gives them the incentive to sell you on the most expensive car they can. While many good dealers take into account your financial situation, many are just out to maximize their profits. Knowing your budget can protect you and your finances.

Joshua Cox-Steib

Personal Finance Contributor

Joshua Cox-Steib is a personal finance contributor. He lives in Tulsa, OK, with his wife and their three pets. He spends his spare time reading, writing, and gardening. Find out more on Joshua Cox-Steib at www.jcswriting.com.