How Much Car Can You Afford? Understanding the Numbers

Auto Loans, Loans
How Much Car Can I Afford? Understanding the Numbers

Before you drop by a car dealership and inhale that intoxicating new-car smell, you need to estimate the cost of a new car — and we’re not just talking about the monthly car loan payment — so you can understand how it fits into your budget.

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Keep this in mind before you decide to just wing it at the dealership: If you take a few minutes to understand some key figures, you will save hundreds, maybe thousands, of dollars in the long run. Not only that, you won’t be putty in the hands of a car salesman.

What does ‘affordable’ really mean?

Lots of guidelines and even some affordability calculators aim to help you answer the question: How much can I afford for a car? But it’s fairly simple. You earn a certain amount of money and you have to spend some of it on expenses, including food, rent or mortgage, utilities and commuting. How you divide up the remaining money — and how much of it you spend on a car — is up to you. While there are practical limits, the way you slice up your spending is partly emotional.

It’s important to keep perspective when you watch those seductive TV ads urging you to spend with wild abandon on your next car. You want to spend wisely so you don’t find yourself with bills that exceed what you can afford.

Break it down

When you’re shopping for a car, you need to think about more than just the price on the window sticker — no matter what those commercials say. Here’s a list of expenses those car-selling celebrities on TV don’t mention:

Fees and add-ons: Dealers usually advertise a base model in an ugly color. The model you want is at least $1,000 more plus options. And then there’s sales tax, registration fees and a “documentation fee,” all of which inflate the price by about 10%.

Dealer-installed options: Some car lots put extras on a car — chrome wheels, alarms or running boards — and you only find out about the extra cost later. Steer clear of these options unless you really need them.

Upsells and warranties: You came to buy a car, but when you go to sign the contract, the finance manager will try to sell you warranties and protection plans, often at an inflated price.

Total cost to own: Once you drive off the lot, the expenses continue: car insurance, yearly registration fees, gas, maintenance, repairs and — worst of all — depreciation.

Once you know about all these extras, you can begin to see what your true budget should be. Like so many things, it’s easiest to view it on a monthly basis. And there’s a rule to help with that.

The 20% rule

Financial experts say your car payment and all other automotive expenses shouldn’t be more than about 20% of your take-home monthly pay. You might find this to be pretty restrictive, so keep in mind that it’s only a guideline. If you’re really into cars, you can spend more than 20% and make up the difference by economizing somewhere else.

As an example of the 20% rule, if your monthly paycheck is $3,000, the total of all your auto expenses should be no more than $600. In addition to your car payment, you also need money for gas, insurance, registration fees, maintenance and repairs. So, realistically, your car payment should be about $350, leaving $250 for other car-related expenses.

Your monthly payment depends on two factors:

  1. Your down payment and your trade-in value, if any.
  2. The length of your car loan.

Use an auto loan calculator to figure out these different factors. Once you have numbers that fit your budget, you’re finally ready for the fun part: choosing your car.

How much can you afford for a car?

Many automotive sites, such as Kelley Blue Book, Edmunds and AutoTrader, have car finder search tools to show you different models listed by price. But remember to set the bar low. If you’re considering a new car loan for $25,000, you should set your maximum price at $20,000 when searching. Options, sales tax and registration fees can easily add up to that extra $5,000.

Parting thoughts

Few people like to think about budgeting. But once you do the math, you’ll have a much clearer idea of what car to buy and how to make the most of your automotive budget.

Philip Reed is a staff writer at NerdWallet, a personal finance website. Email: preed@nerdwallet.com.


Image via iStock.