In a perfect world, we`d all drive (or be driven in) our dream cars. What exactly those are, of course, varies from person to person. One person`s Flying Spur is another person`s 911, is another person`s Grand Cherokee and so on. However, the nature of life imposes certain limitations on most of us. Therefore it`s important to ask how much car you can afford — before you go shopping for an automobile.
What`s an Appropriate Car Payment?
Most experts recommend limiting your monthly car payment to 10 percent or less of your monthly take-home pay. In other words, if you`re making $5000 a month, a car payment of more than $500 monthly on a 60-month new car loan is ill advised.
If you`re buying a used car, you`ll want to limit that time period to 36 months.
Sure, you could get a car payment well below $500 with a longer loan term. However, you`ll be taking on a number of unwise perils to make that happen. You`ll risk making payments on a car you`ll be paying to repair.
You`ll be likely to owe more than the car`s fair market value. And (yes, there`s still more), you`ll pay a lot more in interest, which will make the total price you’ll pay for the car higher.
Long story short, if you need to finance a new car for more than 60 months (or 36 on a used car) to comfortably make the payments, you can`t afford that car.
Will Your Budget Allow It?
That whole 10 percent of your income thing assumes your other financial obligations leave you room to apportion that much for a car. Of course, that can be a big assumption with the vast majority of Americans carrying some sort of debt.
It is therefore prudent to weigh your income against your expenses before committing yourself to that 10 percent figure.
To do so, list your monthly fixed costs (rent, insurance, cable, phone, internet, utilities, gas, food, and etc.), also taking into account your savings and investments. You`ll also need to consider insurance, fuel and maintenance for the car in this category.
Next, determine how much your debt payments for credit cards, student loans, medical bills and the like come to each month.
Ideally, your total monthly debt payments should consume no more than a third of your income. And, yes, your $500 car payment would slot into this category.
A third of $5,000 comes to just over $1600 monthly. Given your car payment should require no more than 10 percent of your income, that leaves $1,100 to service your debts.
If you can do that comfortably, while still meeting your fixed costs, you`ll probably be OK. If not, whatever`s left after your debts are serviced is what you can afford for a monthly car payment.
So How Much Car Can You Afford?
Your next step will be to plug the relevant numbers into a car loan calculator. These include the amount of the monthly payment you`ve determined you can afford, the amount of the down payment you have, the interest rate for which you qualify and the loan term you can best tolerate (not to exceed 60 months on a new car, or 36 on a used one).
Ideally, you`ll have at least 20 percent of the purchase price of the car you want to buy on hand as a down payment. If it`s a $30,000 car, you`ll need $6,000 in cash to get the most favorable interest rate available for your circumstances.
We said “your circumstances” because you must have the best credit score possible to get the lowest interest rate. A free copy of each of your three credit reports can be obtained at AnnualCreditReport.com.
Look for discrepancies such as accounts you didn`t open, debts you know you paid off that are still listed as having a balance and etc. Get anything untoward you find cleared up to improve your credit score as much as possible.
Most banks now offer credit score disclosure to their customers as a service. Some even do so for free. With your credit score in hand, you can get an idea of the average interest rate for which you qualify. You can find this information at U.S. News & World Report`s cars.usews.com site each month.
Plug all of that data into your car loan calculator and you`ll get a good idea of how much car you can afford to buy.
You can then proceed to look for a pre-approved loan and narrow your search to vehicles best suited to your needs (and desires) in the price range you can afford.