Cars are a necessity for many of us, and it may be difficult to live without them in some cases.
But buying too much car or a car you can’t afford can slow down your wealth building.
In this post, we’ll cover 3 rules you can use to determine how much car you can afford and some other factors to consider before buying a car.
Table of Contents show
3 Rules of Thumbs For Car Affordability
1. 20-4-10 Rule
This is one of the most popular rules for calculating car affordability.
There are 3 parts to the rule
1st Part: Down Payment:
The first part of the rule says you should put at least 20 percent of the car value down as down payment. Obviously, the more you can put down, the lower your monthly payment and the total interest over the life of the loan will be.
It is estimated that a car can lose up to 20 percent of its value by the end of the first year. And given that a higher portion of the first year’s payments goes toward the interest, a lower down payment may mean you’re owing more than the car is worth by the end of the year.
2nd Part: Loan Term:
The second part of the rule says the term of the car loan should not be more than 4 years.
If you have to take a loan for 6 – 8 years just so you can fit the monthly payments into your budget, you simply can’t afford the car. Be honest with yourself.
A lower term means you will pay lower interest over the term of the loan. Though with rates near zero these days, the interest savings may not be that high.
More importantly, a car can be worth as little as 50 percent of its original price after just four years. Do you still want to be carrying a high loan balance at that time?
3rd Part: Monthly Payment:
This part of the rule brings the cost of the car closer to home – what you pay monthly. It says the total car payment, including insurance, should not be more than 10 percent of your monthly gross income.
For example, you should keep your interest, principal, and insurance payments below $500 if your monthly gross income is $5,000.
Here’s why this is a good idea:
The lower your car payments, the more money you have for your other monthly obligations and saving towards your goals.
Pros of the 20/4/10 Car Affordability Rule
- It’s easy to understand and calculate
- Higher down payment means lower monthly payments, lower interest paid over the life of the loan, and a lower debt load overall
- It puts the focus on paying off the loan fast by capping the term at four years
Cons of the 20/4/10 Rule
- Gross Income: the rule uses your gross income to calculate how much your monthly car payments should be. But after deducting your payroll tax, the take home pay will be quite different from your gross.
- Ignores your other monthly obligations: such as housing, groceries, debt repayments (see below) and savings. If you live in a big city, it is not uncommon for the housing cost to be over 30 percent of your monthly income. Add groceries, child-care, and your savings to this, and you may be left with little wiggle room.
- It does not consider your total Debt load: How much you can afford in car payments should be considered as part of a larger assessment of your other debt obligations. Do you have credit card debt, student loans or other types of loans? How much does the repayments come to every month?
2. Dave Ramsey’s 50% of Annual Income Rule
According to Dave Ramsey, the value of all your vehicles should not be more than 50 percent of your annual income.
His reason is simple:
Cars are a depreciating asset and it make no sense, financially, to put too much money into buying an asset that could lose 50 percent of its value in five years.
Dave Ramsey is also not a fan of buying or leasing a new car in general. He preaches buying an affordable used car with cash. This way, you’re letting someone else pay for that initial depreciation in the value of new cars.
The challenge with this rule is this: it does not account for monthly payments and the other costs of owning a car, such as insurance, gas, maintenance and so on.
Let’s consider an Ontario resident earning $100,000. Using this rule, he can afford a car of $50,000. We’ll assume he’s getting a 4-year loan at 0% financing and a 20 percent down payment. His monthly take home pay is about $6,000 and car payments of $833.
That’s almost 14 percent already, before considering the other costs of car ownership like insurance, fuel and so on.
3. Sam Dogen’s 1/10th Rule
This car buying rule was developed by Sam Dogen of Financial Samurai. It takes a similar approach to Dave Ramsey’s rule – It is also based on your annual income but more stringent.
The rule states that the value of your car should not be more than a tenth of your gross annual income.
According to a study compiled autoTrader, the average price for new cars, including cars, SUVs and Trucks, was $40,490 in 2019.
The median after-tax income in Canada was $61,400 in 2018, with a wide disparity depending on the household composition: singles at $30,700 and families at $91,600.
If we gross up these values to get the before tax median income, calculate a tenth of the result and compare the figure to the average price of new cars in Canada, it is clear that Canadians are spending too much on cars. At least, according to this rule.
I like this rule because it forces you to allocate a relatively small amount to a depreciating asset. Though the rule does not consider what your total car ownership cost will be per month, it should be relatively low.
The Problem With Rules Of Thumb
These rules, like many other rules of thumb, are meant to provide a general guidance and not necessarily an exact figure to work with. They are a convenient way to quickly make a reasonable estimation of how much car anyone can afford.
But no two people or households are alike. There will be differences in financial goals, current savings and investment, car buying pattern and so on. That is why it’s called personal finance.
By all means, start with the rules. The range of figures you get from the exercise is a good starting point. But go beyond that by considering your own specific circumstances – financial and non-financial.
For example, consider two individuals with the same annual income of $80,000. One has a net worth above $1 million while the other is just starting his career and has little savings. The first may decide to take some liberties and buy a $40,000 car, but it’ll be difficult to justify the same decision, financial wise, by the second.
What does this mean for you?
It’s simple. Don’t treat these rules like they are laws of physics that will always hold.
How Much Car You Can Afford: Other Factors
Most of the rules discussed above attempt to recommend an amount based on your income alone. The 20/4/10 rule goes a step further by considering the loan term (maximum of 4 years) and down payment (minimum of 20 per cent).
As mentioned earlier, this is a good starting point. To get a figure that reflects your personal situation, here are some more important things to consider
#1. Why Do You Need The Car
Do you see a car as a necessity? Something that can take you from one place to another reliably.
Or
You see cars as objects of luxury to show class and status, and have to be changed every few years to reflect the latest trends?
#2. Your Net Worth
Net worth is a better indicator of how good your finances are than just your income. It is simply the difference between your assets and liabilities.
But it tells a better story about how you have managed money in the past, your spending habits, your saving and investment, the assets you have acquired and their quality and so on.
If you’re still in the accumulation stage, there are more important things than buying an expensive car.
#3. Car Buying Pattern
If you’re someone that needs to change your car every 3 years, it’ll be hard to justify even buying a car that’s 10 percent of your annual salary.
On the hand, if you tend to buy a reliable car and drive it for as long as possible, say 10+ years, then buying a more expensive car than be justified as long as it does not affect your other monthly obligations especially your financial goals.
#4. Opportunity Cost Of The Car
Cars are a wasting asset. Whether you pay cash upfront for a car or make monthly payments over some years, there’s an opportunity cost for the cash outflow.
The money could have gone towards saving for a house, retirement, children’s education and many other financial goals. You should be asking yourself how much you’re saving by not buying that car.
Of course, this assumes that you’re disciplined enough to actually invest the money you saved by not buying a car, or buying a cheaper one, in an earning asset.
So before you buy a $30,000 car that would have lost most of it’s value after 5 years, you need to consider how that money would have compounded in the same period if you invested it in the stock market, and how that will get you closer to your financial goals.
Alternatives To Buying Another Car
Here are a few other options to consider before buying another car:
- Stick with your old car
- Take public transit: Bus, trains and so on
- Use ride-hailing services like Uber or Lyft
- Sign up for car-sharing or peer-to-peer sharing services: Turo and Zipcar
- Use Rental cars
- Bicycling
Final Thought
Before buying that new car, ask yourself these questions:
- How much am I saving by not buying a new car?
- Have I considered all my options?
- Can I justify the new car considering my current net worth?
The more money you have invested in things that go down in value, the longer it will take to achieve financial freedom.
Keep this in mind when thinking about how much car you can afford.
Related Posts:
- 15 Must Ask Questions When Buying A Used Car
- 10+ Ways To Get Cheaper Car Insurance Rates
FAQs
How much should you spend on a car rule of thumb? ›
In general, experts recommend spending 10%–15% of your income on transportation, including car payment, insurance, and fuel. For example, if your take-home pay is $4,000 per month, then you should spend $400 to $600 on transportation. To be sure, that range is simply for guidance.
How much of a car can I afford based on salary? ›One simple rule you could apply to your car purchase is spend no more than 30% of your annual income on the vehicle of your choosing. This allows your budget to be flexible enough to cover the additional costs of maintenance, insurance and other expenses.
How much car can I get approved for? ›Follow the 35% rule
Whether you're paying cash, leasing, or financing a car, your upper spending limit really shouldn't be a penny more than 35% of your gross annual income. That means if you make $36,000 a year, the car price shouldn't exceed $12,600. Make $60,000, and the car price should fall below $21,000.
Basically, the rule goes that you provide a down payment of 20% of the balance, sign a loan for a four-year period, and pay no more than 10% of your monthly income on car expenses. These expenses include any money you put towards your new vehicle, including gas, insurance, and loan payments.
What credit score do you need for a 60k car loan? ›What Is the Minimum Score Needed to Buy a Car? In general, lenders look for borrowers in the prime range or better, so you will need a score of 661 or higher to qualify for most conventional car loans.
What car can I afford with 50K salary? ›The 2020 Hyundai Sonata is one of the midsize cars you can afford if you pull down a $50K salary. With good credit, the $390 monthly payments are affordable for those in that salary range.
How much car can I afford on a $60000 salary? ›It's typically recommended that you buy a car worth no more than 35% of your gross annual income— so if you make $60k per year, you can afford a new car that is worth $21,000 or less. Some cars that fall in this price range include: 2020 Honda Fit - starting price $17,145. 2021 Kia Soul - starting price $18,765.
How much car can I afford with a 75k salary? ›If you make $75,000 per year, your total loan payments shouldn't exceed $2,250 per month. The 20/4/10 rule: Put down 20% on a car, finance the car for no more than 4 years, and keep your car payment less than or equal to 10% of your salary.
How much can I afford on a car with 100k salary? ›In fact, some experts even say to keep your total car cost — including your other car ownership expenses — to just 10% of your income. For our example $100,000 family, that means you shouldn't spend more than $10,000 per year total on car costs.
Can I get a car with a 500 credit score? ›And, yes, if you are in that 500–600 credit score range, obtaining the financing to buy a car is doable. Even a small percentage of individuals with deep subprime credit scores – 500 or below – obtained auto financing in 2021.
How much is $40,000 car payment for 60 months? ›
When the loan term changes to 60 months, the monthly payment on a $40000 car loan will be $738.83.
What would a car payment be on $40000 for 72 months? ›If you are offered a 2% interest rate for three years (or 36 months), 3% for four years (48 months), 4% for five years (60 months), and 5% for six years (72 months), your monthly payments for a $40,000 loan will be as follows: Three years – $1,146. Four years – $885. Five years – $737.
How much should I spend on a car if I make $20000? ›Personal finance is personal, but everyone wants a rule to follow. So, when pressed, I would say spend up to 35% of your annual income on a car. This covers most bases. If you only earn $20,000 a year, it gives you a budget of $7,000.
What is the 50 30 20 rule car payment? ›Set your car payment budget
50% for needs such as housing, food and transportation — which, in this case, is your monthly car payment and related auto expenses. 30% for wants such as entertainment, travel and other nonessential items. 20% for savings, paying off credit cards and meeting long-range financial goals.
Because depreciation is constant, it's best to sell or trade in your vehicle before it hits the 100,000-mile mark. At this point, you won't get nearly as much for it because dealers generally see these cars as wholesale-only vehicles to be sold at auction.
What credit score do you need to buy a 100k car? ›There is no set credit score you need to get an auto loan. If you have a credit score above 660, you will likely qualify for an auto loan at a rate below 10% APR. If you have bad credit or no credit, you could still qualify for a car loan, but you should expect to pay more.
What does a 700 credit score get you car? ›A credit score of 700 gets you an interest rate of 3% to 6% on car loans for new cars and about 5% to 9% for second-hand cars.
What credit score is needed for a 80000 car? ›The recommended credit score needed to buy a car is 660 and above. This will typically guarantee interest rates under 6 percent. The information provided on this website does not, and is not intended to, act as legal, financial or credit advice.
How much car can I afford making $70000 a year? ›Using an average interest rate, and a car payment calculator, you can afford a $19,000-20,000 car on a $70k salary using the 20/4/20 rule of car buying.
How much can I spend on a car if I make 120k? ›Many lenders approve car loans (and refinance loans) with a DTI around 50%. To find out how much car you can afford with this 36% rule, simply multiply your family's income by 0.36. So if you earn $100,000, for example, you could afford to take out a car loan of up to $36,000 — assuming you don't have any other debt.
How much can I spend on a car if I make 70k? ›
If you earn an annual income of $55,000, for example, that means your budget for a car should be $5,500-$11,000. If you make $70,000, your budget would be $7,000-$14,000.
How much should I spend on a car if I make $80000? ›If you earn $80,000, that's a used car for around $10,000 or $12,000.
Is 800 too much for car payment? ›Experts say your total car expenses, including monthly payments, insurance, gas and maintenance, should be about 20 percent of your take-home monthly pay. For non-math wizards, like me – Let's say your monthly paycheck is $4,000. Then a safe estimate for car expenses is $800 per month.
How much do you have to make a year to afford a 200K car? ›though it's a lot less about “make” and a lot more about “have”. Most people that are driving a $200K car are earning 500K+ and worth 5 million +, whether that's trust fund, or salary, or business ownership/stocks, or some combination.
Is a $500 car payment too much? ›Is $500 Too Much for a Monthly Car Payment? Paying $500 for a car loan monthly payment in 2019 would definitely have been too much. But in 2022, when the average monthly payment is $648, consider yourself lucky if you have just $500 to pay!
How much does a 100K car cost per month? ›This month's 100K Cars lease offers range from effective monthly payments between $1,335.64 to $2,404.64.
What is the rule of thumb car price vs income? ›Financial experts answer this question by using a simple rule of thumb: Car buyers should spend no more than 10% of their take-home pay on a car loan payment and no more than 20% for total car expenses, which also includes things like gas, insurance, repairs and maintenance.
Is it good to put a big down payment on a car? ›A larger down payment also helps you build equity faster and protects you and the lender against depreciation and potential loss. All cars famously depreciate the moment they're driven off the lot.
Is $200 000 a good salary? ›If you had an income of $200,000, that would put you in the top 10% of household incomes or the top 5% of individual incomes in 2021. Though I prefer household income over individual income, no matter how you cut it, $200k a year puts you on the higher end of the income spectrum.
Is paying off car worth it? ›The bottom line
Paying off a car loan early can save you money — provided the lender doesn't assess too large a prepayment penalty and you don't have other high-interest debt. Even a few extra payments can go a long way to reducing your costs.
Can a 800 credit score get you a car? ›
People with a credit score over 800 are also likely to be accepted for other lines of credit, including personal loans, mortgages and car loans.
What is the lowest credit score to buy a car? ›In general, you'll need a credit score of at least 600 to qualify for a traditional auto loan, but the minimum credit score required to finance a car loan varies by lender. If your credit score falls into the subprime category, you may need to look for a bad credit car loan.
What raises credit score? ›One of the best things you can do to improve your credit score is to pay your debts on time and in full whenever possible. Payment history makes up a significant chunk of your credit score, so it's important to avoid late payments.
How much is a $35,000 car loan payment 72 months? ›If you take out a $35,000 new auto loan for a 72-month term at 4.0% interest, then your monthly payment will be $547.58.
What is the monthly payment for a $40 000 car? ›For $40,000 loans, monthly payments averagely range between $900 and $1,000, depending on the interest rate and loan term.
How much is a $400 a month car payment? ›In the example we've given, a car payment of $400 per month for five years (60 months) equates to $24,000. But the same $400 per month spread out over six years (72 months) is $28,800, while it's $33,600 over seven years (84 months).
What happens if I pay an extra $100 a month on my car loan? ›Paying extra on your auto loan principal won't decrease your monthly payment, but there are other benefits. Paying on the principal reduces the loan balance faster, helps you pay off the loan sooner and saves you money.
Is it smart to finance a car for 72 months? ›72-Month Car Loan Rates Are Typically High
To compensate for the added risk, they often charge higher annual percentage rate (APR) or interest rates. There's no benefit to paying more money in interest, and it's considered by some to be wasted money.
The monthly car payments on a $30K car loan range from $505.94 to $834.15. Payments vary based on your credit score, and the sales tax rate of your state, and whether you are financing a new or a used car.
How much is payment on $25,000 car? ›Rates and terms are subject to change without notice. Example: A six year fixed-rate loan for a $25,000 new car, with 20% down, requires a $20,000 loan. Based on a simple interest rate of 3.4% and a loan fee of $200, this loan would have 72 monthly payments of $310.54 each and an annual percentage rate (APR) of 3.74%.
How much is a monthly payment on a 20k car? ›
For instance, using our loan calculator, if you buy a $20,000 vehicle at 5% APR for 60 months the monthly payment would be $377.42 and you would pay $2,645.48 in interest.
How much does the average millionaire pay for a car? ›Drive Used Cars
They understand that cars are depreciating assets, especially brand new ones. Most of the millionaires surveyed said they never spent more than $65,000 on an automobile. Over 50 percent of these cars are American made with 3 in 10 millionaires driving a Ford F-150 pickup.
As a general rule of thumb, it's recommended that you put down at least 20% on a new vehicle, and at least 10% on a used car. Depending on the car's selling price, this could mean shelling out quite a bit of cash. Down payment examples for new cars.
What is considered a high car payment? ›Generally, however, a car payment is considered high if it exceeds 10-15% of a person's gross monthly income. This means that if a person earns $3,000 per month, a car payment that is greater than $300-$450 per month may be considered high.
What happens if I pay an extra $50 a month on my car loan? ›What happens if I pay an extra $50 a month on my car loan? If you pay extra toward your car loan, the principal of the loan goes down more quickly. This translates into paying less interest overall in the long run and, as you said, paying off your loan early.
Will car prices go down in 2023? ›Prices could drop up 5% for new vehicles and 10% to 20% for used vehicles in 2023, according to a report in November from J.P. Morgan. The basis for the prediction is that demand has stabilized and vehicle inventory is improving.
At what mileage do cars lose value? ›If your vehicle has more than 100,000 miles on it, that is a red flag for potential buyers. Even if your car has been dependable over 200,000 miles with relatively few problems, resale value is going to take a huge hit. The average person puts between 12,000 and 15,000 miles on their vehicle in a given year.
At what mileage is it best to trade in a car? ›30,000 To 40,000 miles
The depreciation of your vehicle will generally begin to accelerate faster after this milestone, so the closer your car is to this mileage, the better your trade-in will likely be.
In fact, some experts even say to keep your total car cost — including your other car ownership expenses — to just 10% of your income. For our example $100,000 family, that means you shouldn't spend more than $10,000 per year total on car costs.
What is the 20 3 8 car buying rule? ›The 20/3/8 car buying rule says you should put 20% down, pay off your car loan in three years (36 months), and spend no more than 8% of your pretax income on car payments. As we go into depth to determine how realistic this rule is, you may consider whether it can actually help you budget for your next car.
How much should I spend on a car if I make $70000? ›
If you earn an annual income of $55,000, for example, that means your budget for a car should be $5,500-$11,000. If you make $70,000, your budget would be $7,000-$14,000.
How much should I spend on a car if I make $120000? ›Many lenders approve car loans (and refinance loans) with a DTI around 50%. To find out how much car you can afford with this 36% rule, simply multiply your family's income by 0.36. So if you earn $100,000, for example, you could afford to take out a car loan of up to $36,000 — assuming you don't have any other debt.
How much should you put down on a $20 K car? ›This varies by lender, and some may accept the lesser amount. On a $20,000 car, that would be up to $2,000 down. There's another common adage for down payments though, and it mostly holds true. If you're financing a used car, you should aim to put down at least 10%; put down 20% or more on a new car if you can.
What is the rule of 72 car loan? ›What is the Rule of 72? The Rule of 72 is a calculation that estimates the number of years it takes to double your money at a specified rate of return. If, for example, your account earns 4 percent, divide 72 by 4 to get the number of years it will take for your money to double.
What is a 50 30 20 budget? ›One of the most common percentage-based budgets is the 50/30/20 rule. The idea is to divide your income into three categories, spending 50% on needs, 30% on wants, and 20% on savings.
How much is a $40,000 car payment? ›If you take a car loan of $40000 at an interest rate of 4.12% for a loan term of 72 months, then using an auto loan calculator, you can find that your monthly payment should be $628. When the loan term changes to 60 months, the monthly payment on a $40000 car loan will be $738.83.
Is a $800 car payment too much? ›Experts say your total car expenses, including monthly payments, insurance, gas and maintenance, should be about 20 percent of your take-home monthly pay. For non-math wizards, like me – Let's say your monthly paycheck is $4,000. Then a safe estimate for car expenses is $800 per month.
Can I afford a 300k house on a 70k salary? ›The house you can afford on a $70,000 income will likely be between $290,000 to $360,000. However, your home-buying budget depends on quite a few financial factors — not just your salary.
How much should I spend on a car if I make $80 000? ›The Frugal Rule: 10% of Your Income
If you earn $80,000, that's a used car for around $10,000 or $12,000.
The monthly car payments on a $80K car loan range from $1,297.61 to $2,159.06. Payments vary based on your credit score, and the sales tax rate of your state, and whether you are financing a new or a used car.