Buying a car is a major financial decision. Spending too much can hinder your ability to save for other financial goals and even limit your freedom to travel and enjoy your purchase. Determining how much car you can afford based on your salary is crucial before you begin shopping. This article will guide you through various methods to calculate a comfortable car budget.
Common Rules of Thumb for Car Affordability
Several personal finance guidelines offer helpful starting points for determining car affordability:
The 50% Rule: Total Vehicle Value vs. Take-Home Pay
Financial expert Dave Ramsey suggests that the combined value of all your vehicles should not exceed 50% of your net income. For example, a household with a $50,000 annual take-home pay should aim for a total vehicle value of no more than $25,000.
The 36% Rule: Debt-to-Income Ratio (DTI)
The DTI ratio compares your total monthly debt payments to your gross monthly income. Lenders often prefer a DTI of 36% or lower. This includes mortgage or rent, credit card payments, student loans, and any potential car loan.
For instance, if your gross monthly income is $8,333 ($100,000 annually) and your existing monthly debts total $2,400, your current DTI is 29%. To stay below the 36% threshold, your car payment should not exceed $583.31 per month.
Payment-to-Income Ratio (PTI)
PTI focuses specifically on the car payment compared to your gross monthly income. Lenders generally prefer a PTI between 10%-20%, though a higher credit score might allow for a slightly higher PTI. Using the previous example, a $583.31 car payment results in a 7% PTI.
The 10% Rule: Total Car Expenses vs. Income
This rule suggests limiting all car-related expenses, including the car payment, insurance, gas, maintenance, and registration, to 10% of your gross income. This provides a comprehensive view of car affordability beyond just the loan payment.
A Step-by-Step Approach to Determine Car Affordability
While the rules of thumb offer general guidance, a personalized approach is essential:
Step 1: Budget Assessment
Analyze your monthly income and expenses to understand your disposable income after covering essential needs. This determines the maximum amount you can comfortably allocate to car-related costs.
Step 2: Factor in Ongoing Costs
Calculate estimated monthly expenses for gas, insurance, maintenance, registration, parking, and licensing. Deduct these from your disposable income to determine the maximum affordable car payment.
Step 3: Explore Loan Options
Utilize online car affordability calculators to explore loan options that fit your budget. Experiment with different loan terms, interest rates, and down payment amounts to find a suitable car price and monthly payment. A larger down payment can significantly increase your purchasing power.
Average Car Spending in the US
According to Experian, the average new car purchase price in 2019 was $32,797, while the average used car purchase price was $22,267 from a dealership and $18,058 from a private seller. Comparing these figures to your calculated budget will provide further context.
Conclusion
Determining car affordability relative to your salary is crucial for responsible financial planning. Utilize the rules of thumb and the step-by-step approach to establish a realistic budget. By carefully considering your income, expenses, and loan options, you can confidently purchase a car that aligns with your financial capabilities and avoid future financial strain. Remember to factor in ongoing maintenance and ownership costs beyond the initial purchase price. Enjoy your new car!
