The car-buying process starts with determining what payment you can afford. It’s also a good time to account for all the auto-related expenses that go along with owning a car. This is easy to do, and it will keep you from losing your head and buying a car you really can’t afford.
Here are a few guidelines to help you figure out how much to budget for a car payment.
Balance your budget and your life
Using a balanced budget is a simple approach to managing your finances and will help you find that magic number for the right car payment.
NerdWallet recommends using the 50-30-20 rule, where you divide your expenses into three categories:
- 50% of your take-home income for needs such as housing, food and transportation.
- 30% for wants, such as entertainment, travel or upgrading your ride.
- 20% for savings, paying off credit cards and meeting long-range financial goals.
» MORE: Calculate your car payment
Your car payment is a need
Your monthly automotive budget is made up of more than just the car payment.
The monthly payment for your auto loan and all automotive-related expenses fall into the “needs” category. As you choose a car, you should estimate the total cost of ownership for your car or cars, if you have more than one.
Your automotive budget is made up of more than just the car payment. Additional expenses include gas, repairs and maintenance, parking and even tolls. Use our total car cost calculator to estimate all of your automotive expenses.
The 20% rule and car payments
Experts recommend spending no more than 20% of your take-home pay on car costs.
Most financial planners recommend that all your automotive expenses equal no more than 20% of your take-home pay. So if your monthly paycheck is $3,000, the total of all your auto expenses should be no more than $600. Start by deducting what you expect to pay for gas, insurance, registration fees, maintenance and repairs. In this example, if your other car-related expenses total $250, your car payment should be about $350.
At this point, you might be feeling let down, as if we’re going to tell you that you can afford only a beat-up Yugo. But there is an interesting caveat to all this careful planning we recommend.
Get what you want — within the budget
Remember the balanced-budget approach? It has that “wants” category. Some of that discretionary money can be used to cover a car payment. So if having an expensive car is important to you, go for it — as long as the total budget remains balanced.
» MORE: How much is your car worth?
Avoid a costly car payment mistake
Once you’ve determined the monthly payment you can afford, consider what goes on under the hood when the lender calculates your payment. Factors include:
- The loan amount.
- The annual percentage rate (APR), which includes the interest rate.
- The length of the loan.
You could waste a lot of money by focusing only on the payment and ignoring your total financing costs. For example, take a look at how two vastly different loans can result in the same car payment.
|Monthly payment||Loan amount||APR||Term||Total interest|
Similarly, while many people take out a longer loan to get a more affordable car payment, they often end up paying considerably more over the life of the loan.
» COMPARE: Car loans for good, fair and bad credit
Putting it all together
Once you’ve done some simple planning and see that your car payment is only part of the overall picture, you’re ready to get down to brass tacks. Here’s how to run the numbers:
- Multiply your monthly take-home pay by 0.2 to get 20%.
- Estimate your monthly car-related expenses: gas, insurance, repairs and maintenance.
- Subtract the car-related expenses from 20% of your take-home pay.
- You now have the maximum car payment you can afford.
- Use NerdWallet’s auto loan calculator to design your deal, tailoring the loan length and interest rate to your personal situation.
Now that you have this key piece of information, you’ll be much better equipped to negotiate a good deal and have a car payment that actually fits in your budget.