How much car can you afford? Answering this question is critical to your finances. To help, we’ve analyzed several rules of thumb along with our own approach so that you can decide for yourself how much to spend on your next car.

Buying a car should be a calculated decision. It’s a major purchase and for many it’s the next biggest purchase to buying a home. There’s much more to consider than just the cost of the vehicle and the monthly payment.

Other considerations should include the cost of car insurance, gas, and regular maintenance. With just about any vehicle, whether it’s brand new or just new to you, it’s going to mean higher insurance rates. If you’re buying used, you can expect to pay maintenance costs sooner rather than later.

But that still leaves unanswered the critical question–How much car can (or should) you afford?

Rules of Thumb

The general rule of thumb is that you should not spend more than 20% of your monthly take-home pay on cars, according to Edmunds.com (via Bankrate). So if your after-tax monthly income is $4,000, your total cost of car ownership for ALL of the cars you own should not exceed $800 under this rule.

I don’t want to put a damper on your dream of having a flashy sports car. But to be clear, this percentage includes the cost of all those other things mentioned above like insurance, gas, and maintenance.

Dave Ramsey takes a balance sheet approach. Rather than looking at monthly transportation costs, Dave recommends buying cars that cost no more than 50% of your annual income. So if you make $50,000 a year, you should not spend more than $25,000 for a car(s).

The Dough Roller Approach

Here’s my rule of thumb–pay cash. Now I can hear what you’re saying. You just graduated from college and have a great job making $60,000 a year. But if you pay cash, you’ll be lucky to drive to work in a car that cost $2,000. Everybody else will be driving new cars that cost “just” 60 “easy” payments of $500. So you want me to drive a sled (as they use to say in my day)? Yep.

DR, is that what you did when you got out of school? Nope. And I regret it. Do everything in your power to pay cash for your car. And if that means driving around in car that doesn’t compare well to the cars your co-workers and friends are driving, so be it. That’s the advice I’ll give my children. And that’s the advice I wish I had followed.

Car Purchase Calculators

Recognizing that you may not follow my advice, here are some online car calculators to help you decide how much car you can afford. You plug in a few pieces of information. Then the calculator tells you what you can afford.

MSN Money Car Loan Calculator
Edmonds.com Auto Calculator
Bank Rate.com Auto Calculator
Cars.com Calculators
Car Loan Calculator

Tips For Staying Within Your Budget

Now that we’ve faced the cold, hard truth that buying a car is more about what you can afford and less about what you wish you could have, here are some tips to stay within your budget:

• Arrange Financing In Advance (assuming you ignore my advice): You don’t have to rely on the dealership to get you financing. You can compare rates between banks, credit unions, and loan organizations before you even head to the dealership. Find out ahead of time what you can get approved for. This way you can keep the financing out of the negotiation process. Dealerships often offer very attractive financing rates, but not everybody qualifies for these rates. If you don’t qualify, you might end up getting locked into a loan with a higher rate if you rely on the dealership for financing. Also, once you have a car loan, your goal should be to get it paid off as quickly as possible. One thing to consider is whether you can save money by refinancing your auto loan.
• Avoid Paying For “Extras”: Don’t go for the extra fees and service offered by car salesperson. Often you will be offered things like rustproofing, fabric protection, paint protectant, etc. Try to determine ahead of time if these are things you really need so that when under pressure you don’t make a rash decision.
• Don’t Pay Sticker Price: There is always room to negotiate, so don’t assume the sticker price is what you have to pay for the vehicle. This is why you should do some research before taking your test drive. You want to find out what the dealer paid for the vehicle and start your negotiations from there. A reasonable price to start negotiations is 1 to 5 percent over what the dealer paid, depending on the demand for the vehicle.
• Negotiate, Negotiate, and Negotiate More: Once you have your heart set on a vehicle (that’s within your budget) be sure to negotiate each point separately. Salespersons like to wrap it all into one big negotiation: the financing, trade-in value, monthly payment, etc. Break down each of these pieces of the deal, and negotiate them each as individual factors.

As a final tip, I’d suggest you begin the negotiation long before you enter the showroom. Get prices via fax, phone, or email. It makes comparing offers very easy, and you avoid hours in the showroom while the salesperson runs back and forth between you and the “manager,” a process specifically designed to put you at a big disadvantage.

Next Steps

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Topics: cars • financial planning

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