The answer to how much money you should spend on a car, like the answer to many car-buying questions, varies based on a handful of factors. It’s important, though, to figure out an appropriate amount to pay on a monthly basis so you don’t cripple yourself financially – all it takes is some basic math surrounding your income, budget and the costs associated with owning a car.
Don’t Surpass 15 Percent of Your Monthly Income
A common rule of thumb for a safe monthly car payment is to spend no more than 15 percent of your post-tax monthly income. For example, if you take home $40,000 annually after taxes, you could spend as much as $500 on your monthly car payment. However, it’s important to note that this recommendation can change based on your other recurring expenses.
Factor in Other Monthly Expenses and Car Ownership Costs
For somebody who has only the cost of living to worry about, that 15 percent figure probably makes sense. Unfortunately, not everybody falls in that category due to common expenses like student loan and credit card payments. If you’re on the hook for recurring monthly payments like these, you should limit your car spending even further by accounting for all costs related to owning a car.
Depending on how much money you have tied up in other debts and expenses, you should consider spending no more than 10 to 15 percent of your post-tax monthly income on all transportation expenses. The costs can add up quickly as you account for insurance, gas, parking, registration, maintenance and repairs, so take the time to learn how much money these might run you throughout the life of your loan and divide that into a monthly figure.
Determine Which Cars You Can Afford
Once you’ve estimated your budget and researched vehicles, use a car affordability calculator (those of you who hate math will appreciate this tool) to find out whether the cost of a given model aligns with your budget. As you use the calculator, experiment with the down payment and loan term length to see how changes affect the maximum vehicle cost that you can afford. And don’t forget to subtract the added expenses mentioned above before you enter a number for the monthly payment.
Here are some other points to think about as you assess your finances to buy a car:
Remember that your monthly payments for a given loan term will decrease as your initial payment increases.
If you’ve saved up enough to afford a larger down payment, it’s a good idea to give thought to lessening your loan term to limit the amount of interest you’ll pay and gain full ownership of the vehicle sooner.
Lengthier loan terms may make monthly payments more affordable, but they'll cost more in interest and increase the risk of you owing more money than the car is worth at some point.
Don’t lose sight of the purchase price of the vehicle at the dealership. It’s important for you to determine what you can afford each month in preparation, but be aware that bite-sized monthly payments sometimes lead shoppers to blow the negotiation and pay too much overall.