How Much Car Can You Afford?

I‘ve been talking to my children about finances a lot lately. As they near high school graduation (one senior, one junior), I grow more and more concerned about their ability to handle money. And last week the talk centered around how much you should spend on a car.

Why am I worried? Well, my daughter wants to buy a black Cadillac Escalade and my son talks a lot about a Lamborghini. Now this could well be just teenage talk, much of which makes absolutely no sense anyway, but I’m still worried. And this got me to thinking about the cost of buying and owning a car.

Buying a car should be a calculated decision. It’s a major purchase and for many it’s the next biggest purchase to buying a home. There’s much more to consider than just the cost of the vehicle and the monthly payment. Other considerations should include the cost of car insurance, gas, and regular maintenance. With just about any vehicle, whether it’s brand new or just new to you, it’s going to mean higher insurance rates. If you’re buying used then you can probably expect there will be maintenance costs sooner rather than later.

But that still leaves unanswered the critical question–How much car can (or should) you afford?

Rules of Thumb

The general rule of thumb is that you should not spend more than 20% of your monthly take-home pay on cars, according to Edmunds.com (via Bankrate). So if your after-tax monthly income is $4,000, your total cost of car ownership for ALL of the cars you own should not exceed $800 under this rule. I don’t want to put a damper on your dream of having a flashy sports car, but to be clear, this percentage includes the cost of all those other things mentioned above – insurance, gas, maintenance.

Dave Ramsey takes a balance sheet approach. Rather than looking at monthly transportation costs, Dave recommends buying cars that cost no more than 50% of your annual income. So if you make $50,000 a year, you should not spend more than $25,000 for a car(s).

The DR Approach

Here’s my rule of thumb–pay cash. Now I can hear what you’re saying. You just graduated from college and have a great making $60,000 a year. But if you pay cash, you’ll be lucky to drive to work in a car that cost $2,000. Everybody else will be driving new cars that cost “just” 60 “easy” payments of $500. So you want me to drive a sled (as they use to say in my day)? Yep.

DR, is that what you did when you got out of school? Nope. And I regret it. Do everything in your power to pay cash for your car. And if that means driving around in car that doesn’t compare well to the cars your co-workers and friends are driving, so be it. That’s the advice I’ll give my children. And that’s the advice I wish I had followed.

Car Purchase Calculators

Recognizing that you may not follow my advice, here are some online car calculators to help you decide how much car you can afford. You plug in a few pieces of information and the calculator tells you what you can afford.

MSN Money Car Loan Calculator
Edmonds.com Auto Calculator
Bank Rate.com Auto Calculator
Cars.com Calculators
Car Loan Calculator

Tips To Staying Within Your Budget

Now that we’ve faced the cold, hard truth that buying a car is more about what you can afford and less about what you wish you could have, here are some tips to stay within your budget:

  • Arrange Financing In Advance (assuming your ignore my advice): You don’t have to rely on the dealership to get you financing. You can compare rates between banks, credit unions and loan organizations before you even head to the dealership. Find out ahead of time what you can get approved for and this way you can keep the financing out of the negotiation process. Dealerships often offer very attractive financing rates, but not everybody qualifies for these rates. If you don’t qualify you might end up getting locked into a loan with a higher rate if you rely on the dealership for financing.

    Also, once you have a car loan, your goal should be to get it paid off as quickly as possible. One thing to consider is whether you can save money by refinancing your auto loan. MoneyAisle is currently offering $50 Cash Back when you refinance an auto loan. More importantly, they make it easy to compare refi rates online.

  • Avoid Paying For “Extras”: Don’t go for the extra fees and service offered by car salesperson. Often you will be offered things like rustproof, fabric protection, paint protectant, etc. Try to determine ahead of time if these are things you really need so that when under pressure you don’t make a rash decision.
  • Don’t Pay Sticker Price: There is always room to negotiate, so don’t assume the sticker price is what you have to pay for the vehicle. This is why you should do some research before taking your test drive. You want to find out what the dealer paid for the vehicle and start your negotiations from there. A reasonable price to start negotiations is 1 to 5 percent over what the dealer paid, depending on the demand for the vehicle.
  • Negotiate, Negotiate, and Negotiate More: Once you have your heart set on a vehicle (that’s within your budget) be sure to negotiate each point separately. Salespersons like to wrap it all into one big negotiation: the financing, trade in value, monthly payment, etc. Break down each of these pieces of the deal and negotiate them each as individual factors.

As a final tip, I’d suggest you begin the negotiation long before you enter the showroom. Get prices via fax, phone, or email. It makes comparing offers very easy, and you avoid hours in the showroom while the salesperson runs back and forth between you and the “manager,” a process specifically designed to put you at a big disadvantage in the negotiation process.

Published or Updated: June 12, 2013
About Rob Berger

Rob founded the Dough Roller in 2007. A litigation attorney in the securities industry, he lives in Northern Virginia with his wife, their two teenagers, and the family mascot, a shih tzu named Sophie.

Comments

  1. Don’t forget to shop used! You can get a nearly new car for a deeply discounted price and shave thousands off of the new car price!

    • Rob Berger says:

      Nice point. That’s what I did on my last purchase and saved about $6k.

  2. Great article! Many years, a college professor told his class to invest in assets that appreciate. He further stated the “fancy” car comes when you are financially secure not after graduation. I’m extremely grateful for his advice so I thought I’d pass it along.

    • Rob Berger says:

      It’s good advice! Thanks for sharing.

  3. T.A. says:

    I found this post so relevant and easy to understand! I am a high-school student – junior, to be specific – who is currently taking a Personal Finance class at the Singapore American School. Just a few weeks ago, we just finished a car project that dealt with the same sorts of things that you mentioned in this post. Our assignment was to find a financially smart car for someone who had just graduated from college. We were then to choose two other cars that people may be tempted to choose and show how, when all costs were taken in account, they were not, in fact, smart choices. We considered several different factors such as insurance, taxes, gas, mileage, depreciation (assuming we resold the car 5 years after purchase), oil & filter changes and break pad & lining changes. After doing research and calculating total costs, our #1 choice was a second-hand Honda Civic. We also kept in mind what percentage of a college graduates real income (ie. after taxes) this car would take up. We used $45,000 as a benchmark. Not only did we consider all the costs that I mentioned, but we even kept the car’s environmental effects (“green-ness” and its practicality in mind. By practicality, I mean whether or not this car is common and whether it could be easily serviced in almost any car garage. Our two “worse” options were a new Lexus CT and a Volkswagen Jetta. We took this even further. Rather than stopping at the difference between the smart car and the two less smart cars, we decided to invest this difference in the stock market (we assumed the average rate of return to be 9%) for 30 years in order to find out the opportunity cost. The opportunity costs ranged from $25,000 to $325,000. That’s A LOT of money that could be saved by making a smart decision on which car to purchase. In my class, we have also been talking about the fact that cars are depreciating assets so it is better to allocate money into appreciating assets such as real estate or an education.

    It almost scares me just how similar your blog post is to the project that we did! Additionally, I found your real thumb particularly simple, yet clever because by paying in cash, the consumption payment link is not severed, so the consumer knows exactly what the effects of a purchase are on his/her take home pay. The car purchase calculators are also very useful, and could have helped us a lot had we known about them when we were doing our project about a month ago.

    All in all, I can very much relate to this post and I think it is so cool that I actually understand everything you are talking about. The way you organized it in a clear manner just makes it that much easier to comprehend.

  4. Javy says:

    Hey Rob,

    I’m a high school student taking a personal finance class in Singapore, and I really enjoyed reading this post. I find it especially relevant because the situation your kids are in (trying to pick out their first car) is the same predicament I’ll face in the next couple of years. I completely agree with your strategy of paying cash for a first car; I think that’s great advice. But my parents won’t commit to help pay for my first car, so I’ll have to save up in order to buy the car with cash, and I was just wondering if you had any tips for me about saving and budgeting wisely. Thanks, and great post!

    Javy

  5. Jason says:

    With a 50K annual salary, I’m getting a car loan of $16,000 for 0.0% to be paid off in 36 months. I believe this would be an exception to go ahead and get that loan right?

  6. Annoymous says:

    Buying an expensive luxury car is the best investment one can make! Sure there is the depreciation factor; but that goes along with being the owner of the luxury car. Owning a spanking new luxury car puts you ahead in life and is part of telling the world your lifestyle of who and what you are as a person. In other worlds; you are a somebody in this world as oppose to a nobody! That counts for a lot in my book! Go buy the car of your dreams and don’t let income limit your choice on cars. Let the dealership that you buy your luxury car do the worrying since they are the one’s that are responsible in making it all happen. You just in it for the “ride”.

Speak Your Mind

*