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How Much Money Should I Spend on a Car?

how much money should i spend on a car
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If you’re thinking about buying a car, you might be wondering how much money should I spend on a car? There is no one easy answer to this question, but there are some guidelines you should consider before heading to the dealership. Knowing these will help you make the right decision for your specific situation.

how much money should i spend on a car

How Much Money Should I Spend on a Car?

The problem with new cars today is that they are becoming so expensive that the average person can no longer afford them.

They end up taking out a seven-year loan just to afford the monthly payment. Even then, your monthly car payment may be too high for your budget.

So before you sign on the dotted line on an auto loan, you need to understand just how much you should be paying depending on your income and other financial responsibilities.

There are three rules you can use to help you determine how much you should spend on a car.

1. The 35 Percent Rule

The first rule is the 35 percent rule.

This states that you can spend up to 35 percent of your annual income on a car.

This is pretty generous and might be a stretch for some folks when it comes to your monthly payment.

For example, if you make $45,000 per year, using this rule means you can spend up to $15,750 on a car.

I know that sounds really low in today’s crazy high car and truck prices, but it will serve you well when it comes time to make the payments.

Besides, you can find a nice used car in that price range.

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This rule also means that if you make $100,000 dollars a year you can buy a car for $30,000.

Keep in mind that this purchase price doesn’t include a trade-in or downpayment.

If you have a trade-in or a large downpayment, then you can tack that amount onto the price of the car you want to buy.

For example, if you are looking at spending $20,000 on a new car and you have a trade-in worth $5,000 and another $5,000 cash as a downpayment, then, in reality, you could purchase a $30,000 car.

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2. The 10 Percent Rule

The 10 percent rule is quite conservative.

If you want to be really frugal and not have a lot of debt, then consider using this rule.

It simply means that you won’t spend more than 10 percent of your yearly salary on a car.

So if you are making $ 45,000 dollars per year, you would purchase a car that costs no more than $4,500 dollars.

While that may seem like nothing, you can still find a decent car that will get you to where you need to be in this price range.

It might not be anything to write home about, but it should run and that’s what counts.

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3. The 20 Percent Rule

You’re comfort level with debt and your own personal financial outlook and situation will help you determine how much you should spend on a car, but if the 10 percent rule is too little for you, and the 35 percent is too high, then taking the average at 20 percent might be just right.

It’s a little like Goldilocks and the Three Bears when it comes to determining your comfort level.

The point is, you should avoid, at all costs, spending more than 35 percent of your salary on a car, or you might find that your monthly budget gets thrown out the window and if you have an emergency, you may not have the money to cover it.

For example, I know someone that just purchased a new Jeep.

Her loan payment is about $500 per month for seven years, and that is with a trade-in worth $22,000 dollars.

The Jeep was $50,000 before trade-in and discounts.

That means she should make $143,000 dollars a year following the 35 percent rule to buy that car.

I happen to know she doesn’t make anywhere near that.

That is why she is stuck with large monthly car payments for so many years.

So, what happens if she gets sick or loses her job?

She may discover that she can’t make her payments and she would lose her car.

It’s something to think about before you take the plunge and buy a car for a lot more than you should.

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How Much Should I Put Down on a Car?

When it comes to how much you should put down on a car, there is a rule of thumb.

It is kind of like buying a house.

You should plan to put down at the very least 20 percent of the purchase price.

There is a good reason for this.

Your car loses value the moment you drive it off the lot.

In fact, it can lose up to 9 percent of its value at that moment.

Within the first year, it can lose up to 19 percent of its value.

That means if something happens and you have to get rid of the car or your car gets totaled, you will end up owning more than what it is worth.

This is considered negative equity.

One way around this is to always buy a used car.

Don’t forget to check out the Kelley Blue Book value of the car you plan to buy before you go shopping. This can put you in a better position at the dealership.

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The Actual Cost of Buying a Car

There is a lot more that goes into the cost of buying a car than just the purchase price. Before you buy, give these some thoughts as well.

Sales Tax

Depending on where you live, you will have to pay sales tax on your new vehicle. That can be 7 or 8 percent of the price.

That means if you are buying a car for $25,000, the sales tax can be as much as $2,000.

Also, tax laws can change without you realizing it.

Here in Illinois, you now have to pay tax on the amount you receive for your trade. This is new, but it can also add up if you are trading in a car worth a good deal of money.

Car Insurance

The more expensive the car, the higher the car insurance.

Keep that in mind, when the salesman is trying to talk you into buying an expensive vehicle.

Where you live and how much you drive also play a big part in how much your insurance will cost you.

Just be sure to add this in when you buy as it will increase your monthly vehicle costs.

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Maintenance Costs

Even if you buy a brand new car, you will still have maintenance costs.

That might be an oil change, quarterly maintenance that the dealership requires, or even new tires at some point.

My friend that bought that new Jeep actually had to buy an insurance policy to cover her tires. They cost $800 dollars each. Crazy, but true.

Gas

Gas is pretty inexpensive in most of the country right now, but it could always go up.

Keep that in mind when you buy.

Some of those expensive, shiny new vehicles use a lot of gas, and you will have to fill up the tank at least a couple of times per month.

How Many Years Should You Finance a Car?

Car buyers should plan on financing their car for no more than 4 years. This might mean you have a larger monthly payment, but you will be paying less interest over the loan term.

Do what you can to avoid the longer loan terms.

Dealerships and lenders use these 5, 6, and 7-year loans to rope you into a more expensive vehicle.

It benefits them greatly, and it is exciting to drive an expensive car off the lot, but it does serious damage to your personal finance and ability to afford a nice home, savings, retirement, and even trips when you have a longer loan term.

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Factors to Consider When Buying a New Vehicle

Before you decide to buy a new vehicle, you want to take a good, hard look at your current financial situation.

The last thing you want to do is to get into a situation where something comes up and you can’t make your car payment and you find your vehicle being repossessed.

So, take some time to think about the following.

Credit Score

How is your credit score? This is one of the major determinations to whether or not you can even buy a new car.

If it is poor but good enough to get approved, you can expect to pay a much…much higher interest rate.

Instead of the zero interest rates or 1 percent rates you see on TV, you could find yourself paying 13 or even 19 percent.

So, if you have a bad credit score, consider working on that before you buy.

It will save you thousands of dollars over the term of your loan.

If your score is good to great, then you should be able to take advantage of some of the deals that are offered.

Take-Home Pay / Monthly Income

What is your annual income and how secure is it?

You should have already given this some thought to determine how much to spend on your new vehicle, but if you haven’t now is the time.

And while what you make is important, how secure your job is, is also a consideration.

How long have you worked at your current employer?

Are there layoffs or cutbacks of any kind?

The last thing you want is to buy a new car and then lose your job a couple of months later.

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Emergency Fund

All the financial experts will tell you that you need an emergency fund.

They won’t agree on how big it should be, but they will tell you that you need one, and they are right.

Before adding new debt, be sure you have an emergency fund.

You don’t want to have to use credit cards or borrow money from friends or family if something comes up.

You also want to be able to pay your car payments if you lose your job or get sick and can’t work.

A good starting point is having at least 3 months worth of monthly expenses in the bank.

Six months is even better.

Debt

You will also want to take a look at your current debt to determine if you can actually afford to add in a car payment or add in a larger car payment.

Some of your debt you should look at can include the following.

Be sure you bring in enough income to cover any debt you have before you decide to buy a new vehicle.

Affordability Calculator

If you’re wondering whether or not a new car is in your future and if you can actually afford one, check out this free affordability calculator.

To Sum it Up:

Yes, it is exciting to think about expensive cars and what it would be like to own one, but do yourself a favor and stick to one of the three rules of buying a car. You will be much happier each month when you have to make the payments.

 

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