Families need cars. They’ve become an essential part of life, mainly because of how our cities are built. Family homes are in the suburbs. Therefore, if you want to go to the store or take your kids to school, you almost always need your own vehicle.
Unfortunately, cars are becoming increasingly expensive. All the extra safety features and regulatory requirements are leading to higher prices.
What’s more, they’re downright expensive to run. Fuel prices are going through the roof, and many families are worried about how they are going to make ends meet. Buying a car feels like a scary prospect.
Figure Out Your Budget
The first step is to get a handle on your budget. The goal here should be to have a price in mind for how many vehicles you can realistically afford.
There are a bunch of rules for doing this. But one of the most popular is to limit vehicle expenditure based on household income.
Most finance professionals recommend that you spend no more than 10 to 15 percent of your annual income on a car. That means that if your household income is $50,000, you should be looking to spend between $5,000 and $7,500 on a vehicle.
That’s not a great deal when you consider the grand scheme of things. Hardly any manufacturers make vehicles brand new at that price. However, you should be able to find good deals on the used car market.
Remember, that’s just the purchase price of the new vehicle. You also need to make sure that your running costs, such as gas, insurance, and maintenance, don’t exceed 20 percent of your annual income. If they do, then you may struggle to budget elsewhere, say, for example, on your home.
A multitude of factors, though, go into determining what you can afford, and what you can’t. Therefore, the figures presented in this section are little more than a guide.
How To Work Out What You Can Afford
Most people don’t buy vehicles with cash. Instead, they get some sort of finance deal. With leasing, many of the costs of ownership are bundled into a single price.
Before buying a car, you should consider each of these expenses individually. This way, you can build a more accurate picture of what you can afford.
Start by exploring the trade-in value of your existing vehicle, if you already have one. Trading in a car can make your new purchase cheaper by taking advantage of some of the capital you’ve already built up. (This is not a good option if you are still paying off the old loan).
Let’s say, for instance, that you want to purchase a car for $30,000. According to the figures outlined above, you’d need an income of at least $200,000 per year, not realistic for most families.
However, it might be affordable if you could get some money for your old vehicle. Let’s say that your current car is worth $15,000. The new vehicle would then cost you the same amount, which is sustainable on a household income of $100,000.
Dealers can also factor in any loans that you still owe on your old vehicle, paying them off for you. For instance, if you still have $5,000 left on the loan, the dealer would offer you $10,000 off your vehicle’s price.
Consider The Loan Term
Next, you’ll want to consider the loan term, that is, how long your loan will last. Most car loan schemes run between two and seven years. It doesn’t make much sense to go beyond that because of depreciation. There’s a risk that the car could wind up being worth less than the loan you own on it.
In general, the shorter the loan, the higher the monthly payments. That’s because you have less time to pay back the full loan amount. If you want to reduce monthly payments, you’ll need to increase your loan’s term. However, this also leads to more interest payments over time. Therefore, the total cash you dedicate to purchasing your vehicle is higher and the longer you’ll need to pay for it.
Consider The Down Payment
The next factor to consider is the down payments. The majority of experts recommend that you put around 20 percent of the value of the vehicle down on the car. For instance, if you’re buying a $20,000 car, you’ll want to put down at least $4,000.
While saving for a deposit on a vehicle is annoying, it can help prevent you from going upside down – owing more on your vehicle than it is actually worth because of depreciation.
Consider The Monthly Total Payments
Lastly, you’ll want to add up all these costs and figure out how much your new vehicle is likely to cost you every month, using the 10 to 15 percent rule.
Suppose, for instance, that your take-home pay is $3,500. That means that you can afford to pay between $350 and $525 on vehicle repayments every month.
How much you can actually afford, though, depends on your budget. If you have a family, you may have other expenses you need to take care of.
If you need to lower your monthly payments, you can. Just ask the dealer to extend the loan term. Just remember that if you pay for a car slowly over time, it’ll eat into your long-term wealth.
Consider Your Buying Options
The next step should be to consider which buying option works best for you, based on your financial goals. You don’t always have to purchase a vehicle outright.
The most obvious option is to buy new. This approach is popular among people who love that new car smell and want to avoid maintenance issues for the foreseeable future.
If you do decide to go down this path, be aware that your investment will depreciate in value rapidly. Most vehicles lose around 50 percent of their value in the first five years.
Also, be aware that dealers charge different fees for selling your vehicles. Therefore, prices can vary significantly from one to the next. They may not represent the going market rate.
The next option is to buy a used vehicle. Prices tend to be considerably lower (reflecting depreciation) but reliability becomes an issue. You may have to spend more on maintenance than if you bought a new car.
Buying used cars reduces monthly payments. Their value tends to depreciate considerably slower in absolute terms, so there is less risk of going “upside down.”
You may also want to consider an extended car warranty if you choose either of these methods. This way, you can get more protection against manufacturer faults in vehicles that aren’t your fault. These policies may help you reduce long-term servicing costs on some models over time.
The last option is to lease your car. This approach is perhaps the simplest because you never take ownership of the vehicle. Instead, you just pay a monthly fee for the services the car provides. Fees typically include everything you need, except fuel, so you can easily work out whether you’re within budget or not.
How Much Car You Can Afford, Based On Your Salary
How much car you can afford depends on your pre-tax salary. People earning $25,000 per year should aim to keep their car spending capped to around $208 per month. Those on $50,000 can afford up to $420 per month. Above $75,000 and monthly car expenses can be as high as $625 per month.
What’s interesting about these figures is that they are substantially below what most people actually spend on vehicles. It’s not uncommon for some households on $50,000 per year to spend $1,000 per month on their vehicles.
Other Factors To Consider
The rules outlined above are for the general public. They do not, however, cover every instance and situation.
Let’s say, for example, that you love cars and having a high-end model matters a great deal to you. If this is the case, then it makes sense to spend more on a vehicle and cut down on other things, like housing expenses or vacations.
Similarly, if you have a big family, then it makes sense to spend more money on a car. You need something that can transport all members of the family, so a small city supermini probably isn’t the best option.
Then there are environmental factors to consider. For example, if you live in the middle of nowhere, it makes sense to spend more on a 4X4 vehicle. You need it to get around reliably.
Similarly, if the climate is important to you, then buying an electric vehicle makes sense. And these are usually considerably costlier than their internal combustion engine counterparts.
You might also want to consider whether owning a vehicle is worth it at all, given your lifestyle. If you live in the city center, hiring a vehicle might work out as cheaper.
So, there you have it: a full analysis of how much car you can actually afford.