Know the difference between how much car can I afford and how much should you spend
One of the worst questions you can ever ask is, “How much can I afford?”
It might not be so bad for small purchases like deciding how many avocados you can afford for that expensive avocado toast everybody seems to love.
Asking how much you can afford on the big things like a car and house can put you in a financial crisis.
The problem with asking how much car I can afford is that it sets your expectations at the very limit of what you can manage. It also gives the salesperson an idea of how much useless features and add-ons they can sell you!
Use this guide to understand how much you should spend on a car and how much your shiny new ride is going to cost you.
How much should you spend on a new car?
There’s a huge difference between how much you should spend on a new car and how much a lender will say you can afford. How much care you can afford is the maximum amount you could make on monthly payments given your income.
The problem is that paying as much as you can afford makes you a slave to your car payments for up to eight years. See your income drop just a little and you won’t be able to afford those payments anymore.
You’ll lose your car and all the money you’ve put into it.
To really know how much you should spend on a car, you need to know how much it’s really going to cost.
- Sales tax, registration and dealer documentation costs usually add as much as 10% to the price you agree on.
- The car the dealer shows you is always going to include all the features but the price quoted will be for a base, no-frills model. Make sure to ask how much the price increases for all those extras.
- Monthly cost for gas, insurance and maintenance can be as much as your payment.
A rule-of-thumb for how much car you can afford is 20% of your monthly take-home pay for all costs. That includes gas, insurance, maintenance as well as your loan.
But we wanted to find out how much you should spend, not how much you can afford. To be on the safe side, most experts recommend spending no more than 15% of your monthly income on your car.
- Get an estimate for the monthly insurance cost before buying a car
- AAA estimates the average monthly cost of repairs and maintenance at $99 for a new car but you might want to estimate $125 to be safe
- The average driver spends between $100 and $200 a month in gas
Add these up and you’re probably looking at a minimum of $350 a month in costs beyond your car payment. You can multiply your monthly take-home pay by 0.15 to find the total amount you can safely afford to pay for a car.
For example, if you make $3,200 a month after taxes then you can safely spend $480 a month on your car ($3,200*0.15).
That might not leave much for a car loan but it will save you from getting in over your head on car payments.
How much will a car loan cost total?
Car dealers have gotten sneaky over the past few years. Since worker wages have barely budged while car prices have increased, dealers are offering longer-term loans to make the monthly payments look more reasonable.
It used to be that a 48-month loan on a car was standard. It’s not uncommon now to see people getting 72-month loans and a lot of the used car dealers are offering loans on 100-month terms!
Getting a longer-term loan might lower your payment but it also increases the total cost of your car by thousands. Check your rate and payments on a car loan here.
On a $17,500 car loan and a 3.5% rate, the monthly payment would be $513 on a 36-month loan and you would end up paying almost $1,000 in interest. Extending the loan out to 60-months will decrease the payment to $318 a month but you’ll end up paying $1,602 in interest.
Extend the loan out even further to 96-months and you’ll end up paying almost $2,600 just in interest.
Data from Black Book shows the average value of a used car dropped 17% over the last year. That means that $17,500 car will only be worth $14,525 but you’ll still owe over $15,500 on a 96-month loan.
Don’t get a loan on terms you can’t afford but don’t agree to a long-term loan just because it lowers your payments. If you can’t afford the payments on a 48- or 60-month car loan, consider a less expensive car.
What happens if I can’t pay my car loan?
This is a question more borrowers are asking these days. The fast pace of depreciation and the longer car loan terms means more people owe more on their loans that the value of the car. Experts estimate that 14% of borrowers have negative equity in their car.
Buy more car than you can afford and it will be repossessed. KAR Auctions estimates that two million cars will be repossessed this year, almost double the number repossessed in 2009.
Surprisingly, that’s exactly what a lot of dealers, especially the ones at buy-here, pay-here lots, want you to do.
If a dealer sells you more car than you can afford, collects a year or two in payments and then repossesses the car – he can turn around and resell it to another customer. All the money you paid on the loan principal is the dealer’s extra profit.
Do I qualify for a car loan?
Getting a car loan you can afford means shopping around and even considering other sources of cash with better rates.
Lending Tree is not only one of the largest online sources of mortgage loans but can also connect you to its auto loan network. You’ll be able to compare loan rates from multiple lenders to find the best rate. Always check your rate from different lenders, even if the dealer offers you in-house financing.
Don’t get sucked into a financial crisis by asking, “How much car can I afford?”. Understand the total costs of buying a car and how much money you should spend. Adding in all the monthly costs will help you understand how much car can you SAFELY afford.
About the Author
Joseph Hogue is a financial expert and investment analyst. After serving in the Marine Corps, he started his career investing in real estate before becoming an investment analyst for some of the largest private investors. He's appeared on Bloomberg and on CNBC as an investment expert and has published ten books in personal finance. Now he helps investors reach their financial goals and invest in the stock market with some of the same advice he used when working for the rich.