Buying a car: How much can you afford?

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In a Nutshell

“How much car can I afford?” To answer this question, you’ll need to take a careful look at your monthly income and expenses, and factor in costs of car ownership, including insurance, maintenance, fuel, registration, parking and, of course, your monthly payment if you have a car loan.

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“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 expenditure, second only to purchasing a home.

There are more than 200 vehicle models on the market, and their prices vary tremendously. So what’s a comfortable fit for your budget? To arrive at this answer, you have two choices: You can follow conventional wisdom, or you can take a more customized approach to budgeting.

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Conventional wisdom

Conventional wisdom 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 automotive 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 curve ball, like that time you lost your house key and had to get the locks changed on a Sunday evening.

A customized budget

Following conventional wisdom will work just fine for many car buyers. But in some cases, it’s helpful to create a more customized 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.

Net income

This is your take-home pay: gross income minus federal, state and local income taxes.

Current nonautomotive 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 nonautomotive 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 automotive expenses

If, like most people, you’re taking out a car loan to buy your new car, you can count on making a sizable loan payment each month. To estimate your monthly payment, you’ll need to factor in the price of the vehicle and the term of the car loan, as well as interest cost and sales tax.

Your automotive expenses don’t end there. You’ll also need to estimate certain monthly costs when preparing your budget. AAA recommends including costs related to expenses like maintenance and repair, fuel and car insurance as you plan your spending for the month.

  • Fuel — At fueleconomy.gov, you’ll find mileage information for cars on the market. To estimate monthly fuel costs, start by calculating the vehicle’s estimated fuel cost per mile.
    • Divide the current price of gas in your area by the vehicle’s EPA-estimated combined miles per gallon (an average of the city and highway mileage figures). 
    • Multiply this cost per mile by the number of miles you expect to drive each month.
    • For example: If you’re considering a vehicle that gets 30 mpg and the current price of gas in your area is $3.50 per gallon, you’d divide $3.50 by 30 to get a cost per mile of $0.116. If you expect to drive 1,000 miles per month, multiply 1,000 by $0.116 for a total monthly fuel cost estimate of $116.
  • Car insurance Your insurance costs will depend on where you live and the type of vehicle you drive as well as your age, gender, driving record and a few other factors. Your insurance agent should be able to give you estimates regarding 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. It depends on your usage, but your car’s oil usually needs to be changed every 5,000 to 7,500 miles, and brake pads typically need to be replaced after 30,000 to 50,000 miles. Be sure to check your car’s owner’s manual for manufacturer-specific maintenance recommendations. According to a 2018 AAA study, maintenance and repair expenses for a medium-size sedan will cost a driver an average of 8.58 cents per mile driven.
  • Registration — Many states offer online calculators that will estimate vehicle registration fees. The factors that govern registration costs vary from state to state. For example, in New Mexico, the yearly registration fee depends on the weight and model year of the vehicle. Other states, like California, charge a registration fee that varies depending on the vehicle’s 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. Parking costs vary dramatically depending on where you live. According to a 2017 study conducted by INRIX, parking in New York City costs an average of $5,395 per year. Toward the other end of the spectrum, the average yearly cost of parking in Detroit is just $815. The overall average yearly cost of parking across the entire U.S. was $1,607, which works out to roughly $134 per month.

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.

Depreciation

Another expense to consider is depreciation. A new car can depreciate by 20% or more after the first year of ownership, and it continues to lose its value as time goes on. At the end of your car loan, your vehicle will likely be worth significantly less than the amount you paid for it.

Discretionary funds

The final step of creating your budget involves subtracting all current and projected expenses from your disposable 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.

Why everyone should have an emergency fund

You can redo your expense calculations using vehicles at different price points until you have numbers you feel comfortable with.


Bottom line

Spending more on a car than what your calculations show you can reasonably afford may create unnecessary financial stress. You may find yourself choosing between paying for your car costs and covering other necessary expenses. In a worst-case scenario, you could lose the car to repossession or damage your credit.

On the other hand, spending prudently on your new car could leave you with available discretionary income you can spend preparing for your future or doing things that you love.

Learn more: Credit Karma Guide to Budgeting