How Much Car Can You Afford? Understanding the Numbers

Determine how much car you can afford

A vehicle is often one of the most expensive purchases people make so it is critical that you crunch the numbers to determine whether you can truly afford the car you’re considering. And remember — the true cost of a vehicle goes well beyond the sticker price or monthly loan payments. Ongoing costs like fuel, maintenance and car insurance can vary significantly based on the type of car you purchase and should also be factored into your affordability calculations.

Get an initial figure by using a car loan calculator

The interest rate you receive on an auto loan plays a big part in calculating your monthly payment amount. A higher credit score will score you a lower interest rate, which will ultimately lower your monthly payment and your total overall loan cost.

You can use a car loan calculator to determine how different interest rates will affect your monthly payment. Here is how: 

  • Pull a copy of your credit report and find out your credit score
  • Get prequalified with a few lenders to determine the average interest rate you could be offered. 
  • Plug in your interest rate, desired repayment term length and car price to the calculator.

Bankrate insight Use a car loan calculator to get an idea of what your monthly payments will be before you complete a full auto loan application.

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Most Importantly

The best way to estimate what your car payment might be is to check your credit and then use an auto loan calculator. However, you won’t know exactly what rate and loan amount you qualify for until you apply for a car loan.

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3 rules for financing a car

If you’ve established that financing is the right move for you, what are your next steps? What are some good rules of thumb to follow to ensure you get the best deal from your auto loan? 

Put at least 20% down

The key objective of any loan is this: Don’t go upside down.

You’re “upside down” on a loan when you owe your lender more than the asset is worth — meaning that even if you sell it, you still owe money on something you don’t even have anymore!

Yeah, upside down is not a fun place to be. 

That’s why you’ll often see the number 20% thrown around when it comes to a car loan, a mortgage, etc. Large down payments not only help to reduce your monthly payments, and serve as a good litmus test as to whether you can afford the car — they also erect a dam to prevent you from going underwater. 

Pick a loan term shorter than 48 months

It might be tempting to push out your car loan term on the Car Affordability Calculator to lower your monthly payments. After all, in our earlier example, if we extend the term from 48 to 72 months, the monthly payment drops to just $175.23. 

But pushing out your loan term means you pay much

But pushing out your loan term means you pay much more in total

To illustrate:

  • 48 months X $252.89 monthly payment = $12,138.72.
  • 72 months X $175.23 monthly payment = $12,616.56.

That’s almost $500 more just in interest. Plus, that’s two more years you might have to pay a lender’s higher insurance requirements. Lastly, you don’t want to still be paying off your car as its value plummets after four years, since the risk of going underwater goes higher. 

Your total car monthly payment (interest, principal, sales tax, and insurance) should not exceed 10% of your gross monthly income

This is sort of a more granular version of the 35% rule. 

The 35% (or less) rule gives you a general budget to plug into the search filters on Carmax, Edmunds, etc.

But when it comes down to brass tacks, you’ll want to zero in on the monthly payment. Take your annual income, divide it by 120, and that’s the most you’ll want to pay for a car each month including insurance. 

Read more: Tips for saving on your car loan

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Your Car Payment Is Not Your Only Car Expense

Remember, other than your monthly car payment, you will need to consider insurance, gas, repairs, maintenance, and even parking. Unfortunately, life happens and you may also want to consider other expenses and possible little hiccups. Essentially, if you get a parking or speeding ticket or if your car happens to get towed, ensure that you have the amount to cover the costs.

How Your Credit Score Affects Your Car Loan Affordability

To give you a better idea of how much you could save by building credit before you buy, here are some examples of average loan rates, term lengths and loan amounts on a new car for different credit score ranges based on Experian data as of the fourth quarter of 2018.

Score RangeAverage Loan RateAverage Term Length(in months)Average Loan AmountTotal Interest Paid
300-50014.9%72$26,400$13,700
501-60012.2%73$29,400$12,400
601-6607.9%73$33,100$8,700
661-7805.0%70$33,500$5,200
781-8504.2%63$31,700$3,700

As the table shows, you could potentially save thousands of dollars by increasing your credit score from one range to the next. Even improving your score from the mid-600s to 700-plus could garner you an interest rate 3 percentage points lower on a car loan—which could help you save over $3,000 in total interest.

Of course, building credit can take time, especially if you have some negative items on your credit reports that are dragging down your scores. Here are a few steps you can take to get on the right track:

  • Check your credit reports: Your credit scores are based on information found in your credit reports. By checking your credit report with Experian and the other credit bureaus, you can pinpoint the areas that need to be addressed. Also, check for potentially erroneous or fraudulent information that could be hurting your credit. If you find something you believe shouldn’t be there, you can file a dispute with the credit reporting agencies.
  • Get caught up on payments: If you have any credit accounts that you’re behind on, get current on payments as quickly as possible and make on-time payments going forward.
  • Pay down your credit card balances: If you have high credit card balances, paying them off can reduce your credit utilization rate and help improve your credit score.

Depending on the factors that are influencing your credit scores, taking these steps can help improve your credit scores and help you establish a positive credit history over time.

Step 2: Consult your budget

A good starting point is your budget. Experts say your total car expenses, including monthly payments, insurance, gas and maintenance, should be about 20 percent of your take-home monthly pay.

For non-math wizards, like me – Let’s say your monthly paycheck is $4,000. Then a safe estimate for car expenses is $800 per month. 

How much money should you spend on a car based on your salary?

The rule of thumb among many car-buying experts dictates that your car payment should total no more than 15% of your monthly net income, sometimes called your take-home pay (some might stretch this to 20%, but 15% is more conservative and therefore likely to make budgeting even easier). Your net income is the money you take home after federal, state and local income taxes have been deducted from your paycheck.

Note that this 15% is meant to cover just your car loan payment, and not ongoing car-related expenses like fuel, maintenance and insurance.

The idea behind the so-called 15% rule is that if you limit your monthly car loan payment — sometimes called a car note — to 15% or less of your net income, you’ll have enough money left over each month to cover the rest of life’s expenses, including the occasional financial curveball.

Consider your purchasing options

If you’re on a tight budget, explore all of your options before purchasing a car. Several choices are available, including leasing or buying a used or new car.

Leasing

A car lease allows you to essentially rent a car from a dealership for a certain length of time and mileage. It can be a good option since the monthly payments are lower than those for buying the car outright. However, keep in mind that you’ll have a mileage limit and the money you pay toward your car won’t bring any value to you.

Buying a used car

Purchasing a used car gives you more freedom than a car lease. Used cars tend to be priced significantly lower than new cars, making monthly payments more affordable. Additionally, car expenses such as insurance tend to be lower for used vehicles.

Buying a new car

If you want to purchase a new vehicle, do your research so you know which make and model you want. Knowing a car’s fair market value will help you negotiate the best deal possible at a dealership.

Our recommendations for auto loans

Shopping around with auto loan providers can help you get lower interest rates. Most banks, dealerships and third-party loan providers will give you free quotes. We recommend reaching out to Auto Approve and LightStream for free quotes on auto loan rates.

Auto Approve: Top Choice for Refinancing

We named Auto Approve one of the best auto loan companies of 2022. It has a reputation for being a refinance auto loan specialist, and the company’s lease buyout option makes it a viable option for those looking to purchase a vehicle. Auto Approve offers rates as low as 2.25% APR for those with good credit scores. 

Learn more about the company’s refinancing options in our Auto Approve review.

Summary

The golden rule to car buying is to never spend more than 35% of your gross annual income on a car. 

Now, your reaction may be eh, I was hoping I could spend more…but remember: There are a lot of used cars you can still get within your budget, and all the money you don’t spend can be invested and multiplied. 

If you’re smart and frugal with your money, the Mazda you buy today can become the new Mercedes you drive tomorrow.

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