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How Much Car Can You Afford?

Aug 07, 2018 5 min read Jeff Bounds

Key Takeaways

  • Know your budget before you go car shopping, both for your monthly payment and the overall price of the car.
  • Follow the 20/4/10 rule to reduce payments and pay off the vehicle sooner.
  • To avoid surprises, research insurance rates before you decide on the make and model.


Now that you've decided to purchase a car, it's tempting to follow the financial advice of car dealers and loan officers who have an interest in getting you a low payment (with a high overall cost). This "affordable" approach to car buying can be more expensive over the long term, and it can leave you stranded with a large loan balance the next time you're in the market for a vehicle.

 

 

The best strategy is to know the amount you're able to spend each month, as well as the general terms you're willing to agree to (total purchase amount, length of the loan, interest rate, etc.).

To formulate your budget, consider using Bankrate's 20/4/10 rule:

  • Make a down payment of at least 20%.
  • Borrow for four years at most.
  • Spend a maximum of 10% of your gross monthly income (before taxes and deductions) on loan payments and insurance on your new ride.

Here is how this rule can be applied to three different financial situations.

 

Young family

Jennifer and Steve are shopping for a new SUV. The Nashville, TN couple have two young children whose abundant chauffeuring needs will only continue to grow. Both in their late 30s, mom and dad want a dependable vehicle that can be passed on to the kids when their oldest, Jacob, starts to drive in eight years.

Combined, their gross annual income is $140,000 before taxes and deductions. But it gets gobbled up quickly.

Here's a snapshot of their monthly income and spending:
 

Scenario 1: Young Family
Young Family: A dependable vehicle that can grow with them. Gross income: $11,667 (before taxes and deductions), Take home pay: $8,892, Expenses: $7,908, Savings: $35,000. New SUV: $33,225 (sticker plus tax, title and registration. Total loan: $26,580. According to the 20/4/10 rule, young family can buy a car when they make a 20% down payment of $6,645 are financing the car for 48 months with the interest rate of $3.89% and insurance(mothly) for $52 and the monthly payment of $599 does not exceed 5.15% of the gross income after subtracting from insurance.

Baby boomer

Mary, 55, never imagined life without her husband, John. But the Columbus, Ohio resident recently lost him to heart disease.

She has determined she must replace her consistently unreliable 2010 SUV, which also has 120,000 miles on it.

A receptionist at the local elementary school, she must create a budget without the $60,000 salary John made as a machinist in the auto workers union.

Before taxes and deductions, her gross annual income is $30,000.

Here is a snapshot of Mary's monthly spending:
 

Scenario 2: Baby boomer
Baby Boomer: In Pursuit of Dependability. Gross income: $2,500 (before taxes and deductions), Take home pay: $1,985, Expenses: $1,359 Savings: $35,000. Life insurance payout: $60,000 2016. Sedan: $15,260 (sticker plus tax, title and registration Total loan: $9,808. According to the 20/4/10 rule, Baby Boomer make a 20% down payment of $2,454 are financing the car for 48 months with the interest rate of $4.75% and insurance(mothly) for $53 and the monthly payment of $225 does not exceed 9.2% of the gross income after subtracting from insurance.

Established family

Bill and his wife, Eva, enjoy a comfortable lifestyle thanks to Bill's role as vice president at one of Los Angeles's professional sports teams.

Soon it will be time to hand down his sedan to his 15-year-old daughter, Maya, who aspires to find her first job after getting her license.

Eva, a stay-at-home mom, uses their SUV for her many civic activities. Now in their 40s, the couple has paid off both cars.

Including his bonus, Bill's gross annual income is $320,000 before taxes and deductions.

Here's how their monthly money picture looks:
 

Scenario 3: Established family
Established Family: Preparing for the next phase. Gross income: $26,666 (before taxes and deductions), Take home pay: $17,416, Expenses: $10,898 Savings: $90,000. Luxury electric car: $133,200 (sticker plus tax, title and registration Total loan: $106,560. According to the 20/4/10 rule, Established Family make a 20% down payment of $26,640 are financing the car for 48 months with the interest rate of $3.0% and insurance(mothly) for $131 and the monthly payment of $2,359 does not exceed 8.8% of the gross income after subtracting from insurance.

What you can do next

Research the insurance rate for the type of car you'd like to buy and get pre-approved for a loan from your bank or local credit union. By having the terms of your financing worked out, you can focus on negotiating the total cost of the vehicle.

 

Jeff Bounds is a freelance business writer in Garland, Texas, a suburb of Dallas. He focuses on finance, technology and law.

 

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