Auto Loans

How Much Car Can I Afford? Establishing a Car Buying Budget

Whether you’re a first-time car buyer or a seasoned owner, determining how much car you can afford can be a challenge. That’s why we’ve broken it all down and showed you what to expect, so you don’t get caught by surprise by expenses or payments you haven’t considered.

The 20/4/10 rule of car buying

Purchasing too much car is dangerously easy to do. In fact, auto loan delinquency is on the rise, as more Americans struggle to make payments on auto loans even as the overall economy has improved.

Don’t become one of those statistics.

One rule of thumb to follow as you begin your car shopping voyage is the increasingly popular 20/4/10 rule:

  • Put at least 20% down.
  • Finance for no longer than four years.
  • Keep total transportation costs below 10% of your monthly income.

This is a solid piece of advice when it comes to purchasing a vehicle, and should help the average car buyer from walking off the lot with a set of wheels he or she can’t comfortably afford.

Putting a larger down payment insulates you from the loss in value that occurs with every vehicle when you drive it off the lot, as well as in the first few years of ownership. By putting 20% down, you have a better chance at avoiding being upside down on the vehicle. When you’re upside down on a car loan, you owe more on your car than it is worth. It’s estimated that a  new car’s value depreciates by 19% after one year. By coming up with a larger down payment, you can be more certain that you’re borrowing against the car’s actual value.

And, of course, you’ll also bring down your monthly payment.

Financing your vehicle for a shorter amount of time reduces the total amount you’ll pay in interest. Don’t let a car sales representative convince you to apply for a super long-term loan in order to get lower monthly payments. In the long run, you’ll always pay more money by dragging out the length of your loan, even though it may feel nice to have a smaller down payment in the beginning.

Lastly, keeping your total transportation costs (this includes your car payment as well as gas, insurance, maintenance, and other costs) to 10% of your monthly income ensures you won’t be sacrificing too much of your take-home pay.

Calculate how much car you can buy

How much you can afford based on income

Even with the 20/4/10 rule, we know you’re going to want to see some numbers based on income.

Here’s a chart showing payment amounts as a percentage of income (10%, 15%, and 20%).

Monthly Car Payment as a Percent of Income
Monthly Income 10% 15% 20%
$2000 $200 $300 $400
Car price: $9,100 $13,700 $18,200
$2400 $240 $360 $480
Car price: $10,900 $16,500 $22,000
$3000 $300 $450 $600
Car price: $13,700 $20,500 $27,300
$3600 $360 $540 $720
Car price: $16,500 $24,600 $32,750
$4000 $400 $600 $800
Car price: $18,200 $27,300 $36,400
$5000 $500 $750 $1000
Car price: $22,800 $34,200 $45,500

*Approximation based on 48-month financing at 2.60%

Setting a budget

Before you begin shopping for a car, it’s important to set a budget. This will provide you with a reasonable expectation about how much car you can afford. Here are some things to consider.

  • Net income: Start with your paycheck. This is what you’re taking home after taxes, insurance, and any retirement contributions are made.
  • Fixed expenses: Subtract your monthly expenses like your rent or mortgage, food, average utilities, and other loan payments.
  • Variable expenses: Consider how variable expenses like needing to buy new clothes or paying for a new air conditioning unit may affect your budget. Make an estimate and subtract this from your net income.
  • Discretionary expenses: Estimate and subtract out your discretionary expenses, like going to the movies or out to dinner.

Take a look at what you have left after factoring all your expenses. This may be less than the 10 percent rule we discussed above. That’s why it’s important to set a budget and determine what’s realistic. If you have other debt you have to pay off, you may need to buy less of a car in order to keep yourself from getting stuck in a loan you can’t afford.

Breaking down the costs

If you’ve ever owned a car, then you know there are costs associated with owning a car above and beyond the sticker price.  Consider all of these costs before making your final decision about how much to pay for the car, because you’re going to need to be able to cover these other costs too.

Initial costs

  • Down payment. Consider putting at least 20% down on a new car to help reduce the risk of having an upside down loan. For a used car, consider at least 10%. If you’re struggling with this decision, read how much to put down on a car.
  • Tax. Tax varies by locality. You can see what your taxes will look like on the Tax Foundation website.
  • State fees. You’ll also spend money on your state license and registration, but you can look up registration and titles fees by state.
  • Dealer options. When you purchase a car at the dealership, you bet the finance person is going to try to upsell you on things like prepaid maintenance and an extended warranty. If you finance these things into your loan, expect the amount your paying for your car and your monthly payment to increase.

Recurring costs

  • Gas. The price of gas fluctuates and varies by location. But you can get an idea of how much it’s going to cost you buy looking at the gas mileage on your vehicle, how much you drive, and the cost of gas.
  • Maintenance. AAA puts out an annual report on how much it costs to drive. The composite average ranges from $0.50 to $0.75 per mile. There’s a section to figure your specific costs.
  • Insurance. The median state average insurance premium was $917 per year from 2010-2014. To get a more exact estimate, get multiple insurance quotes before you buy a car.

Other potential costs

  • Parking. Parking is a concern in crowded areas like New York, where the average cost of monthly parking is $430. Be sure to do a little research into how much this may cost you.
  • Traffic tickets. Depending on your driving habits, the cost of traffic tickets may or may not be a concern. Just keep in mind they can be expensive.
  • Car accidents. No one wants to get into one, but it’s likely that at some time, you’re going to get hit. Here are some crash statistics by state. You may want to plan ahead to be able to pay your insurance deductible.

Look at more than just the monthly payment

Many people make the mistake of purchasing a car based on the monthly payment amount. In fact, it’s one of the ways car salesmen get you to purchase a vehicle at higher price — they simply adjust the number of months you carry the loan in order to bring down the monthly payment.

Other things to consider include the term of the loan and how much interest you’ll pay over the life of the loan. This is important because while a longer term may drop your monthly payment, what dealers won’t tell you is that the amount of interest you’re paying overall goes way up.

For example, a $20,000 loan at 2.60 percent over 48 months will cost you a total of $1,079.66 in additional interest charges. A $40,000 loan at the same rate over 72 months will cost you $3,244.32 in additional interest charges — about $2,165 more.


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