Deciding how much money you can and should spend on a car is no easy task. There are so many rules it can make your head spin. One rule states that all your car-related expenses including insurance should cost no more than 20 percent of your monthly income before tax. Another thought is that a new car should cost no more than half of your annual take-home pay. A more conservative rule is that you should spend no more than 10 to 15 percent of your annual pay on a car.
How much should my car payment be?
There’s no one answer, but you should aim for your monthly car payment to be no more than 15 percent of your monthly take-home pay if you are paying for a new car, and no more than 10 percent if you’re paying for a used car. The reason why this number can seem way too small is that it only includes the car payment and not other car expenses. Car insurance, gas, routine maintenance, repairs - all this should add up to another 5-10 percent of your take-home pay.
How to determine how much car you can afford?
If you want to get a more accurate estimate of how much car you can afford than what the formula above provides, you can use a more time-consuming method that will give you a monthly car payment that you specifically can afford. First of all, sit down and calculate your monthly take-home pay. Next, deduct all of you spending from that number. This includes your mortgage, utilities, cell phone and internet, savings, loan payments, child expenses, food and entertainment, but not your car-related expenses. Whatever is left is the sum you can afford to pay for your car every month.
Next, you need to need to get an estimate of your monthly insurance payment on the new car. This is easy to get from your insurance company using an online insurance estimate tool if you already have a few cars in mind. Same goes for fuel costs - simply determine how many miles you drive on average every month, look up the fuel efficiency of the cars you have in mind and calculate your estimated monthly fuel cost. Ideally, your fuel and insurance costs should be less than 7% of your monthly income. Once you subtract the fuel and insurance cost from the car allowance you’ve calculated in the previous step, you will get the highest monthly car payment that you can afford.