How Much Car Can You Afford?

You need a car but when you look at your budget, you’re not sure what kind of down payment you should make or how much you can afford to pay each month. Maybe you haven’t made a car payment in a while. Or maybe you have been making a payment all along and it’s been putting a damper on your budget. Before you strap yourself into a new car, take a minute to figure out how much car you can afford and still live comfortably within your means.

A rule of thumb for debt payments

One rule of thumb is to spend less than 36% of your gross income (income before taxes and other deductions) on total debt, including credit cards, mortgage, and other loans. (36% is generally accepted as the proper debt-to-income ratio to be at or below. But note that this may not be the best rule of thumb for everyone. You’ll likely want to consider your total budget and how a car payment fits in with your overall income and expenses.) Calculating how much you can afford is pretty simple. You can use an online calculator or do it yourself with the following calculations.

Calculation to determine total debt payments per month

To determine how much debt you can take on per month, you can multiply your annual salary by 36% (.36) and divide that amount by 12. Or to calculate by month, multiply your monthly salary by .36:

Annual salary example:

Your gross income per year is $50,000.

$50,000 X .36 = $18,000
$18,000 ÷ 12 months = $1,500 to spend on debt each month

Monthly salary example:

Your gross income per month is $4,000.

$4,000 X .36 = $1,140 to spend on debt each month.

The calculation for determining car payments per month

Now that you know what you can spend on debt each month (we’ll use round $1,500 from the example above), you need to figure out what portion can go toward your car payment. You are calculating debt only, so don’t worry about groceries, utilities, or other household expenses.

For example, if you’re currently spending $800 on your mortgage and $200 per month on credit card debt, you are already spending $1,000 of out of the total $1,500 you can spend on debt each month. Subtract $500 from $1,500 and you can see that you now have $500 per month (at most) to put toward your car payment.

Other important factors to consider

Before you get excited and look for a car with a $500 per month price tag, consider these things:

• Are you planning on purchasing another large item within the next few years? If so, you may not be able to afford it if your pay doesn’t increase substantially.
• Are you saving enough? If you don’t have an emergency fund or need to save for a down payment on a house or another large purchase, you may want to allocate more to savings. Keeping your monthly payments lower will help you do that.
• Depending on how much of a down payment you make and which terms you pick, you may be paying this amount for a long time. Will you be comfortable with that? One tool you can use is the EastRise auto loan calculator, which estimates your monthly payment based on the loan amount you’re looking for and current rates and terms.
• What other costs come with owning a car? Remember, vehicle expenses include insurance, the down payment, and sales tax, and any financing you take on (including interest). Make sure all of these things are considered when you determine the final price. The dealer can do the calculations for most of that. You may have to figure out the insurance on your own, so make sure to add that in when you make your purchase.

Determine how much you can put down on the vehicle and how much of a monthly payment you can make based on the above calculations and after thoughtful consideration of how the payments will impact your life. If you don’t want to do the calculations yourself, you can speak with a loan officer at your preferred financial institution, but it is often best to do the work yourself so you know you’ll be comfortable with the outcome.

Ways to reduce your payment

Want to reduce your car payment more? Here are some ideas:

• Save before you buy. You can save enough to buy the whole thing or simply save enough for a nice healthy down payment that will lighten your monthly debt burden.
• Buy used. Cars get cheaper the moment they drive off the lot, so buying an older car can save you a lot of money.
• Sell your old car instead of trading it in at the dealership. This can take some work, but you can often get a much better price by privately selling it than the dealership may offer you.