Buying a car is one of the most important decisions in anyone’s life. It will be your transportation and your investment for several years.
It’s hard to know when you should spend more money on a car or when you really need to save money for a car. Some financial experts say you’re safe to spend no more than 35% of your annual gross income– but how much is that, and can you really afford it?
And while a new or nearly-new vehicle can cost over $30,000 or more, there are plenty of options for those on a budget.
How Much Should I Spend On A Car?
According to U.S. News and World Report, in January 2019, the average car owner in the United States spent around $37,000 on a new car. That’s a lot of money!
Deciding on the amount of money you should spend on a new or used car is difficult. It’s not always as simple as picking the cheapest or even the most expensive car prices.
The amount of money you should spend on a car can vary quite a bit depending on your needs and car budget. It also depends on whether you will pay cash or have a loan and monthly car payment for a car.
David Weliver is the founder and writes about personal finance on Money Under 30 suggests breaking down how you should spend on a new or used car into tiers or percentages of your yearly income.
Here are a few tiers for the cash down payment for your car.
10% Of Income
With this tier, whether you are paying cash or making a monthly car payment, you only put 10% of your annual income toward buying a new or used car.
For example, say you make $30,000 a year. Following a more frugal living plan, the amount of money you should spend on a car would be $3,000.
Paying cash for the car in this tier would get you a very high-mileage used car and probably one that is not very dependable if you have a lower income to depend on, or your loan term may not be what you want with a smaller down papyment.
(Side-note: the price of used cars in 2022 jumped considerably due to the shortage of cars caused by the pandemic so car buying may be a different story for a while. Your car buying budget may have to increase if you can’t wait on buying a used car.)
35% Of Income
You put 35% of your income toward buying a new or used car in this tier, which is an average the financial experts recommend. This tier will put a more significant dent in your current monthly budget but will save you money in the long run.
Using the exact $30,000 annual income figure again, you would spend around $10,500 cash to buy a car or use as a down payment with this tier.
50% Of Income (Esh!)
How much car can you buy if you put 50% of your yearly income toward a car purchase?
We’re staying with the $30,000 annual income in this tier. Paying cash for a new or used vehicle would be $15,000.
That’s a BIG Esh! We are not suggesting this to anyone! It will wreck your personal finance and monthly budget unless, of course, you don’t have any monthly bills!
Figure Out Finances
Current Income, Debts, & Credit Score
It is important to have a good understanding of your current income, debts, and credit score before you go shopping for a car loan. Using a budget tool like Empower (formerly Personal Capital) to organize your personal finances so you can see everything at a glance.
Your monthly income, credit report, and monthly debt payments on personal loans or credit cards are just a few things a bank or credit union will look at before giving a loan amount to someone.
Not sure about what your credit report is going to say? You can get a free credit report from Credit Karma right now!
Too much debt can make it challenging to pay off all those bills each month, leaving little leftover for other expenses like getting a new car. Using a debt planner can help you see how to get your debt paid off.
No more than 36% of your income should be debts – if you already have 10% in debt like student loan payments, medical bills, personal loans, or credit card debt, then you can only “afford” 16% more of your gross income in getting a new car loan.
Pick A Target Price Range
When you buy a car, you want to be sure that you are getting the best deal and interest rate possible.
One way is to pick a target price range for the car. This will help keep your spending in check and ensure that you are not overspending on your car.
A good rule of thumb is to add 10% to the advertised price of the car to factor in the sales tax and the fees. So if a car is advertised for $20,000 and you add 10%, you will find that the vehicle’s actual price is $22,000.
Remember to take off your down payment and trade-in value for your old used car if you use it to reduce the price of a new vehicle.
Don’t forget to budget for insurance and other costs as well. By setting a target price range and sticking with it, you will be on your way to finding the perfect car that you can afford.
Determine Estimated Loans Payments
Typically, car payments (including sales tax and interest) should not exceed 10% of your take-home pay in our book. This is to ensure that you have enough money for other necessities, such as food and rent or mortgage payments.
Let’s use a simple example to illustrate how much you can afford. Let’s say your monthly take-home pay is $3,000 – the car payment (including the interest rate) you should budget for is $300 (10% of $3,000).
Calculate Car Payment
If you’d like to find out how much your monthly payment is going to be once you’ve figured out how much you can borrow, visit an auto loan calculator online.
A car loan calculator will give you an estimate of how much your monthly payment will be. Then you can add that to your budget and see how it fits in. It can even tell you how much of a down payment you will need to have to put toward the purchase price.
There are several available online, such as a car affordability calculator and a lease or buy calculator. The online auto loan calculators factor in the loan amount, sales tax, and interest rate on the loan.
Now it’s time for the real car shopping! You can also search online to find a car with the features you’re looking for without going over your budget.
Once you have a rough idea of how much car you can afford and if you need to make a down payment, it’s time to narrow down the search to decide which cars fit within your budget.
A great place to start is at Kelley Blue Book, where you can find the blue book value for any vehicle – new or used car – so that you know if the asking price is too high.
Check Car Insurance Rates
In addition to buying a car that fits your budget, you should also shop around for car insurance rates.
You can get auto insurance quotes online. You may be surprised to discover how much it costs to insure a specific type of used or new vehicle.
Car insurance companies will also use your credit score to determine how much you have to pay in premiums.
If you have a lower credit score, it may take several companies before you find an affordable rate, so definitely check how things are looking with Credit Karma and see if you need to focus on improving your credit score first.
Used Cars Vs. New Cars
Buying A Used Car
If you’re looking for a new car on a tighter budget, think about buying a used one instead.
You can find used cars at great prices that are still under warranty, which means that the manufacturer takes care of most of the costs when something goes wrong.
Just make sure to be thorough in your inspection of any old car you come across, so you don’t end up with a used car that is just going to break down on you quickly and leave you in the lurch
Leasing a New Car
If you’re going to be driving a new car anyway, leasing a car and having a small monthly payment may be the more affordable choice.
Many people prefer to lease rather than buy because they get a brand-new vehicle every few years without having to pay for costly repairs and maintenance down the line.
Just remember that leasing is only ideal if you know you’ll be able to return the car with minimal damage at the end of your lease contract- sometimes you have to pay for damages at the end of your lease!
Buying A New Car
If you want to buy a new car, you’ll need to shop around for the best deal. You can purchase a new car with a car loan or pay the total price in cash.
If you decide to pay in cash, make sure you have all the money set aside and budgeted for your purchase.
Some people like buying new cars with cash because it means they’ll never have any monthly payments to worry about.
Taxes & Fees Of Buying A Car
Car buyers often forget about what goes into the total cost of a car. You know – the fees and taxes that come with buying a car.
These make the cost of auto loans more expensive. Here are a few fees that could be added to your total car cost:
- Documentation Fees – A dealership will charge you a fee for filling out your paperwork and preparing your vehicle for its license plates and registration.
- Title Transfer Fees – The state has a title transfer fee that must be paid when purchasing a new car.
- License Plates & Registration Fees – When you purchase a car from a dealership, they’ll set up your license plates and registration for an extra fee.
- Sales Tax – You’ll have to pay the state’s sales tax on your car.
Find Ways To Save
One of the best ways to save money is by being proactive. You can do many things to save money without making too many sacrifices. We love using these money-saving apps to save:
You can also create an account with Chime Bank and get .50% APY, all by easily automating your savings!
Up Your Income
If your monthly take-home pay isn’t quite high enough to qualify for an auto loan or to pay the purchase price of your car in full, look into getting a side hustle to will bring in a bit of extra cash.
If you’re looking to make extra money, proofreading may be an excellent option for you. Proofreading is the process of reviewing written content to find and correct errors in grammar, spelling, and punctuation.
Freelance writing can be a great way to make money on the side. If you have strong writing skills and attention to detail, freelance writing may be just the job for you!
Freelance writers have the flexibility to work from home, and there are several online freelance writing jobs available. Freelance Write From Home is a great eBook that can help you start freelance writing for high paying jobs.
If you work well with numbers, consider becoming a virtual bookkeeper. A virtual bookkeeper is someone who works remotely and manages business finances, such as invoicing and payroll, before they get passed along to an accountant.
Becoming a virtual bookkeeper can be a great way to make money on the side and pursue your passion for financial management. Not sure how to get started? Bookkeeper Launch has a FREE workshop to help you get started!
“How much should I spend on a car?” is a question that everyone asks at some point- because let’s face it, car costs are daunting these days!
Deciding on the amount of money you should spend on a car is difficult. It’s not always as simple as just picking the cheapest used car or highest rated brand new car.
Car ownership is not cheap, and there are other car expenses to consider besides the vehicle purchase.
You have to pay for everything from the monthly payment to insurance costs, fuel costs, and maintenance costs. A car affordability calculator can help you do some number crunching, but you need to know what you can afford.
Some people have a set budget that they must follow, and if you live paycheck-to-paycheck, you can’t go over it at all! Your take home pay can’t be the same as what you’d spend on a car or car loans.
Buying your own car is a big financial commitment, so make sure you do your research and know exactly what you can afford.