How much should you spend on a car?By: Mike Sante, August 18th 2015
Most Americans are spending far more than they can afford on cars and trucks.
Just because the monthly payments are manageable doesn't mean it's smart to let a $30,000 or $40,000 auto loan gobble up a huge chunk of your paycheck every month.
This is one of life's biggest expenses, and it's a purchase where you have total control over how much you spend.
The car companies know this.
It's why they devote billions of dollars a year to advertising that tries to make this a purely emotional choice. You're urged to choose a ride that tells the world how successful you've been. Or how hip you are.
The automakers want to grab as much of your money as you'll let them take.
Week after week. Month after month. Year after year. They want you to keep paying them.
Yet you can get a great car for much less and use the savings to invest in yourself.
Here’s where the money for your retirement or kids’ college can come from.
It all starts with what we call the "20-4-10" rule, which says you should:
- Make a down payment of at least 20%.
- Finance a car for no more than four years.
- And not let your total monthly vehicle expense (including principal, interest and insurance) exceed 10% of your gross income.
So grab your pay stubs and determine your household's monthly gross income — that's how much you and your spouse make before any taxes or expenses are deducted.
Then find your most recent auto insurance bills, and figure out how much you're spending per month on premiums.
Take 10% of your gross monthly income, and subtract the monthly insurance premiums.
That is the monthly car payment you can afford to make.
Let's say, for example, you earn $53,000 and spend $80 a month for insurance – right at the national median household income and average premium for a single car.
Your monthly gross income would be $4,416, one-tenth of that would be $441 and the monthly car payment you could afford would be $365.
the circle at the top that says you want to calculate the "Total purchase price."
Enter the monthly payment you can afford, and choose to finance the balance over 48 months, as the 20/4/10 rule suggests.
Use 4.3% for the interest rate, which is right at the average cost of a 4-year, new-car loan.
Or search Bankrate's database of the best car loans in your area, and use that rate instead.
Most buyers with reasonable credit will pay less than average for financing.
Under Down payment, enter how much cash you'll be devoting to the purchase and the trade-in value of your existing car or truck.
Under Taxes and fees, enter the sales tax rate for where you live and license your vehicles. Remember that the sales tax rate on vehicles may be different than it is for everyday expenses such as food and clothes.
Hit the "Calculate" button, and the "Total purchase price" will appear at the top of the calculator. That's how much you can afford to spend.
Using our example, with a $365 monthly payment, $3,000 down payment, a sales tax rate of 7% and no other fees, this family could afford to spend $17,822. (See the red arrow below).
Are there situations where you could responsibly spend more?
Let's say the new car or truck you're buying offers a $1,500 rebate that you used to boost your down payment.
If you have decent credit, you might qualify for discount financing from the automaker or a regular loan that costs less than the 4.3% average.
The more you put down, and the lower the interest rate, the more you'll be able to afford to spend.
But be careful.
Longer loans are one of the auto industry's favorite tricks to lower monthly payments and help customers buy more expensive cars than they can really afford.
The 48-month loans we recommend are bad enough, siphoning thousands of dollars in interest from your savings to pay for something that's losing value every day you own it.
Longer loans are just bigger wealth killers. If you need to finance a vehicle for six years, it's a sign you can't afford it.Source: www.interest.com