By Lauren Fix, The Car Coach
We are always talking about buying or leasing a new or used car, but how much can you afford?
This question can be answered with a simple rule of thumb:
Car buyers should spend no more than 10 percent of their take-home pay on a car loan payment and no more than 20 percent on total car expenses, including gas, insurance, repairs, and maintenance.
Once you know the monthly car payment you can afford, you can calculate how much you can afford to borrow for your car loan. With that, you can set a realistic target price and finally answer the question, “What car can I afford?”
How do you Determine how much Car you can Afford?
Calculating how much Car you can afford before you visit the dealership can save you hundreds, maybe thousands, of dollars in the long run — and you won’t be putty in the hands of a car salesman. These three steps are critical NOT to be Car poor.
Calculate the Car Payment you Can Afford
NerdWallet recommends spending no more than 10 percent of your take-home pay on your monthly auto loan payment. So if your after-tax pay each month is $3,000, you could afford a $300 car payment.
It’s essential to be realistic about how long you can or want to be making this monthly payment. NerdWallet recommends maximum loan terms of 36 months for buying a used car and 60 months for new cars.
Taking a longer loan term will reduce your monthly payment, but you’ll pay much more in interest over time. A longer loan term increases your risk of becoming upside-down on loan, meaning you owe more than the car is worth.
How much can you Borrow?
Now that you’ve calculated your affordable monthly car payment amount, you can start to get a sense of how much you can borrow. This will depend on several other factors, including:
- Your credit score will, in part, determine your annual percentage rate, or APR, on the loan.
- Your loan term: how many months you have to pay off the loan.
- New car loans tend to have lower APRs.
- With a monthly payment, an estimated APR, and loan term, the car affordability calculator works backward to determine the total loan amount you can afford.
Set a Target Purchase Price
The total loan amount you can afford isn’t necessarily the price of the car you can afford. If you’re making a down payment or trading in your old car, you’ll be able to buy a higher-priced car or borrow less money.
Additionally, there will be sales tax and fees, so think about more than just the window sticker’s price. Once you estimate the car loan amount you can afford (assuming no trade-in credit or down payment), you can begin to get a realistic idea of the purchase price you should consider.
You’ll need to factor in sales tax and fees, which vary by state. Check out this previous blog on the NMA website for information on dealer fees.
An easy way to estimate these extra expenses is to add 10 percent to the car’s advertised price (even though you might negotiate a lower price). For example, if you see a car advertised for $20,000, you should assume your total cost — the “out the door” price — will be $22,000.
If you want to get a more precise estimate, here’s a breakdown of the typical extra costs:
- Sales tax: Depends on your state, county, and local taxes.
- Registration fees: Estimate these fees by using your state’s department of motor vehicles site.
- Documentation fee: Ranges from $50 to $400, depending on the dealer.
This means that if you can afford a $20,000 car loan, again, assuming no down payment or trade-in credit, you’ll want to shop for a car with a sticker price of around $18,000 so that you’ll be able to cover sales tax and fees with your total loan amount.
Remember to set the bar low. When searching for cars, set your maximum price below the total loan amount you think you can afford. Sales tax and fees can quickly add up to an extra few thousand dollars.
The Bottom Line
Aim to spend less than 10 percent of your take-home pay on your car payment and less than 15 percent to 20 percent on car expenses overall.
Please give us your thoughts by commenting below or on The Car Coach’s YouTube Channel video.
Lauren Fix, The Car Coach®, is a nationally recognized automotive expert, analyst, author, and television host. A trusted car expert, Lauren provides an insider’s perspective on a wide range of automotive topics and aspects, energy, industry, consumer news, and safety issues.
Lauren is the CEO of Automotive Aspects and the Editor-in-Chief of Car Coach Reports, a global automotive news outlet. She is an automotive contributor to national and local television news shows, including Fox News, Fox Business, CNN International, The Weather Channel, Inside Edition, Local Now News, Community Digital News, and more. Lauren also co-hosts a regular show on ABC.com with Paul Brian called “His Turn – Her Turn” and hosts regular radio segments on USA Radio – DayBreak.
Lauren is honored to be inducted into the Women’s Transportation Hall of Fame and a Board Member of the Buffalo Motorcar Museum, and Juror / President for the North American Car, Utility & Truck of the Year Awards.
Check her out on Twitter and Instagram @LaurenFix.