The car-buying process starts with deciding what monthly payment fits into your budget. It’s also a good time to think of 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 answer this important question.
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. The balanced-budget framework recommended by NerdWallet is from “All Your Worth: The Ultimate Lifetime Money Plan,” by Sen. Elizabeth Warren, D-Mass., and Amelia Warren Tyagi.
These experts say you should divide your expenses into three categories:
- 50% of your income for needs such as housing, food and transportation.
- 30% for wants, such as a more luxurious car, entertainment, travel.
- 20% for savings, paying off credit cards and meeting long-range financial goals.
The book goes into a lot of detail about pretax and after-tax considerations. But since most people focus on their take-home pay, we’ll use that approach in this article.
Consider your needs first
The monthly payment on 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 are a family. Your monthly automotive budget is made up of more than just the car payment: Additional expenses include gas, repairs and maintenance, parking and even tolls. Read more here on how to calculate your cost of ownership.
The 20% rule
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, your car payment should be about $350, leaving $250 for other car-related expenses. If you don’t spend much one month on car-related expenses, set aside the extra for future known expenses such as a new set of tires or a brake job.
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.
Don’t ignore your wants
Remember the balanced-budget approach? It does have that “wants” category. Assuming you aren’t using your money for jewelry, cruises or expensive dinners, you can move some of that discretionary money back over to the “transportation costs” category. So if having an expensive car is important to you, go for it — as long as the total budget remains balanced.
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:
- How much is 20% of your monthly take-home pay?
- 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 monthly payment you can afford.
- Use the NerdWallet 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 feel much better equipped to negotiate a good deal and have a car payment that actually fits in your budget.
Philip Reed is a staff writer at NerdWallet, a personal finance website. Email: firstname.lastname@example.org.