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Before you hit the dealership or start car shopping online, take time to determine the maximum car payment for your budget.
Financial experts recommend spending no more than 10% of your monthly take-home pay on your car payment and no more than 15% to 20% on total car costs such as gas, insurance and maintenance as well as the payment.
If that leaves you feeling you can afford only a beat-up jalopy, don’t despair. You can gain flexibility with your car payment using a balanced budget approach. Here’s how it works.
Set your car payment budget
NerdWallet recommends using the 50/30/20 rule when setting your overall budget. To do this, divide your take-home pay into three general spending categories:
50% for needs such as housing, food and transportation — which, in this case, is your monthly car payment and related auto expenses.
30% for wants such as entertainment, travel and other nonessential items.
20% for savings, paying off credit cards and meeting long-range financial goals.
A monthly auto loan payment typically falls into the “needs” category. If you’re buying a car, it’s most likely essential for getting to a job or taking the kids to school.
However, the balanced budget approach can provide flexibility. For example, if you split housing costs with a roommate, you could have a higher percentage available for a car payment in the “needs” category. Or, if you want a more expensive car, you could consider part of your monthly payment as spending in the “wants” category.
The key is keeping the budget balanced overall. If you plan to spend less in some areas, then you may choose to spend more than 10% of your take-home pay on a car payment.
When you know how much your car payment should be, you can back into what you can afford to spend on a car. NerdWallet’s car affordability calculator lets you start with a monthly car payment to estimate a realistic car price.
How do lenders determine a car payment?
The loan amount.
The length of the loan.
The annual percentage rate, or APR, which includes the interest rate and any lender fees.
Having a maximum car payment amount, and sticking to it, can help when negotiating at a dealership. But beware if a dealer encourages you to go with a longer loan term to reduce your monthly car payment and stay within budget. Taking out a longer loan can result in paying considerably more in interest over the life of the loan. NerdWallet typically recommends loans of no more than 36 months for used cars and 60 months for new cars, though that may be more difficult in today’s market.
If you focus only on the monthly car payment and ignore total financing costs, you could waste a lot of money. For example, look at how two different loans can result in the same car payment.
The interest rate on your auto loan also affects your car payment. The rate you pay to borrow money depends on your credit score and other factors, and lower credit scores generally result in higher rates. But rates vary from lender to lender, so it’s smart to shop around to find the most competitive rate on your auto loan. It’s especially important if you need a bad credit auto loan because these loans tend to have the highest rates.
You can use NerdWallet’s auto loan payment calculator to compare various rates and terms.
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When a car payment doesn't fit your budget
If you’ve rearranged your budget, shopped loans and still can’t find a car payment you can afford, you can try a few other options.
Reduce the amount you need to borrow. The less you borrow, the lower your car payment will be. Consider buying less car or saving enough to make a larger down payment. Also, get the best price for any vehicle trade-in by researching online pricing guides like Kelley Blue Book and Edmunds.
Delay buying a car. If you can put off buying a car, you may be in a better place to get a car payment you can afford. In 2022’s market of inflated car prices and payments, the average monthly new-car payment has surpassed $700, according to the vehicle affordability index provided by analytics companies Cox Automotive and Moody’s Analytics. Some car buyers are delaying their purchase, with the hope that car prices — and payments — will eventually fall.
Refinance down the road. If you have no choice but to buy a car with a high monthly payment, you may be able to refinance your car. In particular, if you have bad credit, making six to 12 months of on-time payments on your loan may help you to refinance to a lower rate and monthly payment later.