How Much Should I Spend on a Car Based on My Salary?

Buying a car is one of the biggest financial decisions most people make. With the average price of a new vehicle topping $47,000 in 2022, it’s critical to determine how much you can realistically afford before stepping foot in a dealership. While there’s no one-size-fits-all formula, experts recommend limiting your total monthly car expenses to less than 20% of your take-home pay. Follow these tips to find the sweet spot for your budget.

Set a Target Monthly Payment

As a general guideline, plan to spend no more than 10-15% of your monthly take-home income on a car payment For example, if you earn $5,000 per month after taxes, aim for a car payment of $500-750. This leaves room in your budget for additional ownership costs like insurance, gas and maintenance.

Going above 15% of your income significantly raises the risk of becoming “upside down” on your loan (owing more than the car is worth) It also makes it harder to save for other goals or absorb unexpected expenses,

Calculate Your Total Monthly Car Budget

Your car payment is just one piece of the puzzle. To determine affordability, you need to tally up all expected car expenses:

• Car payment
• Insurance
• Gas
• Routine maintenance and repairs
• Registration and taxes
• Parking

As a rule of thumb, these costs should add up to less than 20% of your monthly take-home income. Tracking your current transportation spending for a few months is extremely helpful for estimating an accurate budget

Adjust for Interest Rates and Loan Terms

While you can control the purchase price, interest rates and loan length also impact affordability. For example:

• A 5 year loan at 4% interest on a $30,000 vehicle equals a $571 monthly payment
• The same loan at 6% interest increases the payment to $609

Run the numbers for different scenarios to see how rate hikes could impact your budget. In general, a 36-60 month loan term offers the best balance of affordability and minimizing interest paid over the life of the loan.

Check Your Credit Score

Your credit score plays a major role in determining your auto loan interest rate. Individuals with scores below 620 often get assigned double-digit rates, while those above 740 can qualify for the lowest rates. Checking your credit a few months before shopping gives time to improve it if needed.

Even a small score boost can make thousands of dollars of difference over the loan term. Tracking your score also alerts you to any fraudulent activity that could derail an application.

Factor in Down Payment Options

While 0% down deals are enticing, a down payment of 10-20% of the purchase price is recommended. By putting more money down upfront, you reduce the amount borrowed and lower your monthly payment. For example:

• $30,000 vehicle price
• 20% down payment = $6,000
• Amount financed = $24,000

Compare different down payment scenarios using an auto loan calculator. Money from a trade-in or sale of your current vehicle can supplement savings earmarked for a down payment.

Look Beyond Monthly Payments

Many buyers focus solely on negotiating the monthly payment amount, without considering the total interest paid over the loan term. An extended 7 year loan drops the payment, but hikes the total interest costs. Review the full principal + interest estimate, not just the monthly payment.

For affordability, a good rule of thumb is that your auto loan shouldn’t exceed 50% of your annual take-home pay. For example, if your annual net income is $60,000, your total auto loan balance should be $30,000 or less.

Choose Your Priorities

Dream cars are nice, but don’t overextend your budget to impress others. List your must-have features, then focus on finding a reliable vehicle that fits your monthly spending plan. Delaying gratification by buying a lower-priced used car to start also frees up cash for other goals.

Review your full financial situation, not just your income. Factors like existing debts, dependents, and emergency fund savings should influence how much you can realistically divert to a vehicle purchase.

Allow Room for Changes

Life happens – you may get married, have kids, or take a pay cut down the road. Avoid tying up every dollar of your current income to retain flexibility. Continually reevaluating affordability ensures your vehicle expenses remain in sync with your financial situation over time.

Use an Online Calculator

Online tools like Kelley Blue Book’s affordability calculator allow you to enter your specific income, costs, loan terms and credit score to determine a recommended purchase price range. The calculator accounts for all the affordability factors and tradeoffs discussed above in one place to take the guesswork out of setting your budget.

Follow the 20/4/10 Rule

As a final gut check, consider the commonly recommended “20/4/10” affordability rule:

• Down payment of at least 20%
• Loan term of no more than 4 years
• Total monthly vehicle expenses of less than 10% of gross income

While tough for many buyers to achieve, it’s a worthy target to constrain spending. Review the criteria to ensure you aren’t way outside the bounds in any category.

Determining how much to spend on a car is ultimately a balancing act between needs, wants, and financial realities. Following these guidelines will help you find the sweet spot for affordability based on your individual income and obligations. Test different scenarios to make an informed purchase that keeps you happily on the road without derailing other goals.