From “Krazy Kevin” selling used cars on radio commercials to the fancy video ads from the car manufacturers, we’re surrounded by people telling us beautiful cars are available to buy and they can help us get into one.
But you don’t want to buy a car and then only eat ramen until it’s paid off — or have it repossessed. So, when and how do you figure out what you can afford?
Setting a car budget you can afford
Figuring out your budget before you go car shopping is important, so you know under what price range to be looking. Having a number in mind before looking at vehicles could save you a lot of stress.
“If you don’t know what you can afford, that would be dangerous,” said Patrick Holmes, a financial services officer at State Employees Credit Union and a member of the National Association of Personal Finance Advisors in Charlotte, N.C. “I would not go to the dealership first thing because you’ll probably walk out with a $20,000 car when you could only afford $12,000.”
In order to figure out what you can buy, first look at what you’re already buying. “Figure out your month-to-month expenses first.” Holmes said. Almost everyone knows how much they make each month, but few people really know how much they spend in the same time period.
When you get your check, you have two basic options on what to do with the money: Spend it or save it.
See how much you spend by adding up your fixed expenses, like rent, insurance, phone, internet and credit card bills. Then figure out how much you spend on more variable expenses, like food, clothing, entertainment, etc. Try keeping a spending journal, using a budgeting app or reviewing your bank and credit card account statements to get a sense of what you do with your spending money on a monthly basis.
Based on how much you have left over (and how much you want to continue saving), you’ll know how much you have available to spend on a car payment. If you don’t have much left over, you’ll need to make some changes to your spending (or find ways to earn more money) before trying to fit in a car payment.
Just because you can spend money, doesn’t mean you should spend it all. Once you decide what you can spend on a car, look at what you should spend. After all, you want to be able to have extra cash on hand in case something on the car breaks or you want to take a vacation. The classic rule is to keep your total transportation costs to under 10% of your monthly income. If that’s not possible, it should definitely be under 20%.
Know the 20/4/10 rule
This is the classic and more frugal guideline for car buying. The 20/4/10 rule is to put 20% down, have an auto loan for 4 years maximum and keep total transportation costs under 10% of your income.
Based on this rule, if the car you want is $20,000, you should give $4,000 as a down payment. If you only have $2,000 as a down payment, you should be looking at a $10,000 car. What’s left over after your down payment, the 80%, is what you get an auto loan for, which, according to this guideline, shouldn’t be more than four years (48 months) long. Whatever you do, it definitely should be under seven years (84 months) long. The last part of the rule is that the total monthly cost of the car (including using the car) should be no more than 10% of your income. You can read more about the 20/4/10 rule here and play around with an auto payment calculator here. Disclaimer: This post contains links to LendingTree, the parent company of MagnifyMoney.
Budgeting beyond the sticker price
So you figured out what you should spend monthly for a vehicle. That amount will need to cover not just the car, but gas, auto insurance, taxes and more. A vehicle is likely to cost more than the neon numbers plastered to its windshield. In this section, we’ll tell you the other costs that come into play with buying and owning a car that often aren’t posted upfront.
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Government and dealership fees
When you buy a vehicle, you generally have to pay government fees, including license and registration. A dealer will usually go pay this for you, which is a great convenience because you won’t have to go to the DMV or tax assessor’s office during normal business hours to fill out paperwork and wait in line to submit it. However, the dealer does not do this for free — it charges administrative and processing fees to do this for you. They often are several hundred dollars and non-negotiable.
State and local taxes
Most states charge a sales tax, and your municipality might have one, too. And you probably won’t get away with going to a sales tax-free state to buy your car. Nicolas Ortiz is an auto adjuster and insurance agent for USAA in San Antonio where he also worked in two auto dealerships as a finance manager. He explained that when you buy a car from a different state, you have to pay the taxes for the vehicle based on the state in which you live. “You pay all applicable taxes and fees to the state where you’re registering the car.” Ortiz said.
Most of these charges are percentages, meaning the lower the price of the car, the less you’ll pay. Still, don’t expect to get off lightly. Ortiz explained to MagnifyMoney, “In my experience, if a state has lower fees, it will have a higher sales tax and vice versa. Expect to pay 8% – 10% of the [vehicle’s] sales price in taxes and fees.”
Gas, car insurance and oil changes are all types of recurring costs. These costs highly depend on which type of car you have and how you use it. If you have an older car and a long work commute, you may have to budget a lot for gas, but it may be cheap to insure. A newer car with great gas mileage will probably cost you less in gas and maintenance, but more in taxes and insurance.
Don’t forget that if you work in a city, you may have to pay to park your car in a lot or a garage close to work. Remember to also account for anything you might add to your loan that you’ll also be paying for monthly, such as GAP insurance or an extended warranty.
Other potential costs
It’s a good idea to set aside money each month for an unexpected car expense, like repairs or traffic tickets (though you should do your best to avoid those). Keep in mind repairs aren’t limited to old cars. For example, the car’s age doesn’t matter much if you run over a nail and need a new tire. Even if a repair is covered by insurance, you may still have to pay a deductible.
Looking at more than just the monthly payment
When you add all of these monthly costs up, it could be tempting to wash your hands of it and say your budget is done. But when you go to actually pick out and buy the vehicle, the best way to stick to your budget is not to focus on the monthly payment.
It’s really easy to justify increases in monthly payments: you may think of a $40 payment increase being equivalent to a nice meal once a month, and you can afford that, can’t you? Turns out, $40 a month for four years, even without interest, is almost $2,000. (To avoid costly errors like this, you could read up on the common car loan mistakes many people make.)
Look at the totals of what things add up to, take the time to shop around for cars, car loans and even car warranties, and don’t be afraid to negotiate. You can shop around for your auto loan on sites like LendingTree to make sure you’re not paying more than you have to in interest.