“How much car can I afford?” It’s a question asked by many car shoppers, and it’s easy to understand why. For many of us, a car purchase is a big expense, second only to purchasing a home.
In September 2020, the estimated average price of a new vehicle in the United States was $38,723, according to Kelley Blue Book. But what’s a comfortable fit for your budget?
To answer this question, you have two choices: You can follow conventional wisdom, or you can take a more customized approach to budgeting.
- How much money should you spend on a car based on your salary?
- A customized budget
- Next steps: Identify cars within your budget
- Hear from an expert
How much money should you spend on a car based on your salary?
The rule of thumb among many car-buying experts dictates that your car payment should total no more than 15% of your monthly net income, sometimes called your take-home pay (some might stretch this to 20%, but 15% is more conservative and therefore likely to make budgeting even easier). Your net income is the money you take home after federal, state and local income taxes have been deducted from your paycheck.
Note that this 15% is meant to cover just your car loan payment, and not ongoing car-related expenses like fuel, maintenance and insurance.
The idea behind the so-called 15% rule is that if you limit your monthly car loan payment — sometimes called a car note — to 15% or less of your net income, you’ll have enough money left over each month to cover the rest of life’s expenses, including the occasional financial curveball.
A customized budget
Following conventional wisdom will work just fine for some car buyers. But in some cases, it’s helpful to create a more-customized monthly budget.
Doing so will give you a detailed picture of your finances, and you can use that picture to get a better idea of how much car you can afford. This can be especially useful if your monthly living expenses are unusually high or unusually low compared to most people.
To go this route, you’ll need to calculate the following monthly income and expenditures.
This is your take-home pay: gross income minus federal, state and local income taxes.
Current nonauto expenses
These include your rent payment or mortgage and expenses related to things like credit card debt, groceries, utilities, entertainment and clothing.
Many people pay their bills using a debit or credit card. If you’re one of them, you can use your bank or credit card statement to get a snapshot of your monthly expenses.
Projected nonauto expenses
Some people buy a car in the context of a major life change, like getting married, starting a family, getting divorced or purchasing a new home.
If you’re buying a car ahead of one of these milestone events, make sure your expense calculations reflect your new (or planned) situation. For example, if you’re expecting a child, you’ll need to make some estimates regarding the monthly costs that will come with raising your young one.
Projected auto expenses
If you’re taking out a car loan to buy your new car, you can count on making a sizable loan payment each month. To find out if you can afford that monthly payment, you’ll first need to figure out what your actual loan amount will be, taking into account any down payment or trade-in value. Let’s say you want to purchase a $20,000 car and you plan to make a $2,000 down payment — your loan amount would be $18,000.
To estimate your monthly loan payment, you can use an online auto loan calculator — enter your estimated loan amount, loan term and interest rate. Keep in mind that you may also need to pay sales taxes when you buy a car, depending on state and local laws.
And your car expenses don’t end there. Consider expenses like maintenance and repair, fuel and car insurance as you plan your monthly budget.
- Fuel — At fueleconomy.gov, you’ll find miles-per-gallon information for cars on the market along with estimated fuel costs. To estimate monthly fuel costs, multiply this cost per mile by the number of miles you expect to drive each month.
- Car insurance — Your insurance costs will depend on where you live and the type of vehicle you drive as well as your age, driving record and a few other factors. Your insurance agent should be able to give you insurance policy quotes for various models. All other things being equal, the more expensive the vehicle, the steeper its insurance cost.
- Maintenance and repair —This includes things like oil changes and brake-pad replacement. Be sure to check your car’s owner’s manual for manufacturer-specific maintenance recommendations. According to a 2019 AAA study, maintenance and repair expenses cost a driver an average of 94 cents per mile driven.
- Registration — Many states offer online calculators that will estimate vehicle registration fees. How DMV fees are calculated vary from state to state. Some states charge a flat fee, while others base registration fees on factors such as the car’s age, weight or current value.
- Driver’s license fees — This is the amount paid to renew your driver’s license every few years. This fee varies from state to state.
- Parking — If you expect to pay for parking at work or elsewhere, include this expense in your budget.
Which cars have the highest cost of ownership?
Keep in mind that the type of vehicle you purchase can affect your monthly automotive expenses. Generally speaking, the smallest vehicles can have the lowest operating costs, while the largest ones can have the highest cost of ownership.
According to information gathered by AAA, the vehicles with the lowest ownership costs are small sedans, hybrids, small SUVs and electric vehicles, in that order. Trucks have the highest ownership costs, followed by large sedans and midsize SUVs.
The final step of creating your budget involves subtracting all current and projected expenses from your net income. This will tell you how much free cash, or discretionary funds, you’ll have available each month after all your bills have been paid.
If you like having a certain amount of extra cash on hand for things like vacations or retirement savings, keep this in mind when deciding how much to spend on your new car. It’s also essential to set money aside for unforeseen expenses.
Next steps: Identify cars within your budget
Establishing an auto budget is an important first step in the car-buying process. Once you’ve landed on a number you’re comfortable with, you can move on to identifying makes and models within your price range before heading to the dealership.
Hear from an expert
Q: Car prices (both new and used) have been trending up and loan terms are getting longer. How are these trends affecting consumers?
A: “Higher prices are obviously not good for consumers. However, they may be mitigated by lower interest rates. Longer loan terms can be beneficial, in theory, with lower interest rates as consumers are extending rates that are low cost. But, in practice, it is often the period of time when consumers own cars and have finished financing where they are most likely to accumulate wealth. Longer terms reduce monthly payments and may give consumers the false sense of having more wealth than they actually do. One must balance both factors when deciding on a car loan.”