As much as we want to believe we’re pretty logical, it’s easy to get swept up in a fantasy world when it comes to buying a car. Many of us are guilty of “falling in love” with a certain vehicle and wanting to stretch our budgets to make it work. It’s hard to walk away from a good-looking car you just took out for a test drive, which is how dealerships often get people to spend more than their budget may be able to comfortably support.
Next time you’re wondering whether or not a car will fit into your budget, keep these ideas in mind.
Refer to the 20/4/10 Rule
An old rule of thumb goes like this:
- You should be able to make a 20-percent down payment on the vehicle,
- You should get a 4-year loan and
- The amount you spend each month on loan payments, maintenance, gas and insurance should be less than 10 percent of your gross income.
Updating this wisdom for our new age, many experts agree five-year loans are pretty typical and can yield good results — just be wary about stretching your financing longer than 60 months to lower payments.
Here’s an example of this 20/4/10 principle in action from The Balance. If you earn $59,000 annually your car-related expenses should be equal or less than $492. Factoring in a 20-percent down payment, you should be able to afford a car with an approximate $20,000 sticker price.
Depending on your circumstances, it may make sense to make slight amendments to this rule. The main considerations are your ability to make the required down payment, the length of the loan and how much of your monthly earnings transportation expenses will command. Keeping all these areas in check will help you avoid blowing your budget.
Consider the Total Price of the Vehicle
When you’re browsing shiny models on the dealership lot, it’s easy to get swept up in the allure of sticker prices. The salesperson might even be able to offer you an “exclusive” deal and knock a little bit more off your price. But, as Auto Trader outlines, a common misstep is considering the base price rather than the total price. The price you pay to get the vehicle out the door may very well be higher than the base price for the model, especially if you’re interested in getting a vehicle with options.
It’s also important to keep in mind that vehicles, just like any other consumer good, carry taxes and fees. Avoid thinking of these as an afterthought; instead, factor them into the purchase price when you’re deciding whether a certain car fits your budget.
Differentiate Between Price & Payment
While it’s helpful and necessary to understand how much you’ll be paying per month, don’t lose sight of the purchase price. Your monthly payments might appear low and manageable at first glance — but what if the length of your loan term had to stretch to make them so? In the end, you’ll be paying much more in interest to finance the vehicle for longer. In other words, your monthly payments can go down while the total price goes up.
A car loan calculator is a useful tool to help you figure out how the price, loan term and interest rate will affect your budget. Play around with these different factors until you find the combination that works in terms of price and payment.
Determining whether a car will fit into your budget is a matter of understanding the variables in play, limiting your transportation costs to a reasonable percentage of your monthly income and basing your calculations on the total cost rather than monthly payments.