How much car can I afford?
You may already own a car, and know somewhat the costs associated with car ownership. But have you ever asked yourself this question: how much car can I afford?
In this post, I’ll discuss the 20/4/10 rule and how it applies to the process of buying a car.
If you can afford to buy a car with cash that’s the best way in my opinion. That way what would have been your car payment, you can invest in index funds instead and watch it grow over time.
When it’s time to purchase another car, use cash to buy the car once again.
Questions to ask yourself.
What if I can’t afford to buy a car with cash?
How do I finance a car or what is the best way to finance a car?
How much car can I afford using the 20/4/10 rule?
What exactly do these percentages represent?
The 20% is the needed down payment of a car.
For simplicity, let’s use $20,000, so 20% of $20,000 equals $4,000 . This is what is needed for a down payment.
If you don’t have the needed $4,000 then you need to go down on the car price you can afford.
The number 4 is the maximum loan term in years or 48 months.
The number 10 represents 10% of the total monthly income that should go to the cost of the car.
These include maintenance and gas and all the other factors that come with owning a car.
Here comes Andrew the car buyer.
Let’s use a salary of $60,000 per year. That’s equivalent to a $5,000 monthly income.
Using the 10% rule, your budget is $500 per month.
You wanted to purchase a $25,000 Honda Accord with these assumptions.
- $0 down payment
- average APY right now is 4.21% according to Value Penguin
- 60 months loan term
- payment per month comes out to $463
- Interest for the duration of the loan is $2,767
We’re still wanting to purchase a $25,000 car
Andrew decided to put $5,000 for a down payment so he’s financing $20,000 with the same interest rate of 4.21% as scenario 1.
- Applying the 4 years part of the rule or 48 months loan
- monthly payment $453 per month
- total interest $1,766 dollars.
In this second scenario, monthly payment is reduced by 10 dollars and the term is reduced from 60 months to 48 months. If you take $453 and multiply by 12 months Andrew saved $5,436 dollars on payments.
Let’s have Andrew buy a beater Honda Civic for $5,000 and save the $453 per month payment. By the end of 4 years, Andrew would have saved up approximately $21,744.
Now he can afford to buy a nicer car if he wanted to.
Granted with a beater car, there are maintenance costs involved. If he were to put his money in a high yield savings account he’d have more than $22,450 saved up.
Car Affordability Calculator
I love online calculators, and Money Uner 30 didn’t disappoint. They have a free car affordability calculator for you to use here. Perusing their article, they also have an auto loan calculator, and a buy and lease calculator.
Check them out and you can play around with different scenarios and see for yourself the interest and savings implications.
As a rule of thumb, they don’t recommend for you to spend more than 35% of your pre-tax money of annual income on a car.
How Much Car Can I Afford? Edmunds Calculator
Edmunds, one of the premier resources online also has a calculator you can use here.
The Edmunds calculator included a section for trade-ins and down payment.
Edmunds recommended a different approach to how much car can I afford question.
The 15% rule of thumb
Edmunds recommends that your car payment should not exceed 15% of your take-home pay.
If you’re leasing they don’t recommend more than 10% of your take-home pay to lease a car.
They estimated that the cost of fuel and insurance will be around 7% of your take-home pay. Altogether, they don’t recommend for you to spend more than 22% of your take-home pay for a car.
Nerd Wallet, another popular personal finance website recommends you not to allocate more than 10% of your take-home pay for a car payment. And you should aim for 15% to 20% overall, taking into account car expenses.
Which car you can own if you make $80k or less
I came across this article on MSN regarding car ownership and I’d like to share their findings with you.
These are the cars and payments per month for those making $80k or less per year.
- 2019 Ford Fiesta ($283 monthly payment)
- Chevrolet Cruze ($356)
- Nissan Frontier ($373)
- Honda Civic ($379)
- Fiat 500 ($425)
- Ford Fusion S ($447)
- Honda Insight-Honda’s hybrid answer to the Prius ($448)
- Chevrolet Malibu ($449)
- Buick Encore ($452)
- Honda Accord ($461)
- Ford Escape ($467)
- Honda CR-V ($471)
- GMC Terrain ($482)
- Honda Accord Hybrid ($492)
- Toyota Tacoma ($498)
- Dodge Grand Caravan ($515)
- Chrysler Pacifica ($519)
- Kia Sedona ($523)
- Ford Fusion Hybrid SE ($535)
- Ford Taurus ($539)
- Chevrolet Impala ($543)
- Ford F-150 ($545)
- Chevrolet Blazer ($555)
- Chrysler 300 ($562)
- Dodge Charger ($562)
- Buick LaCrosse ($568)
- Ford Edge ($575)
- Honda Odyssey ($584)
- Ram 1500 ($610)
- GMC Canyon, 4WD Extended Cab ($617)
How cars keep you broke, the case for not owning a car
All around the world cars are a prized possession.
Reasons why a car is needed.
Cars are linked to great memory/nostalgia. Everyone remembers their first driving experience.
The car allows us to get away from our parents, allows us to achieve a sense of freedom, attending parties, good music, legal and illegal activities.
Overall, the car gives us positive memories.
A car is needed for work, it is a vehicle to get you from point A to point B in order to earn that coveted income.
Nowadays you can use your car and be Uber or Lyft driver so a car can lead to an earning opportunity.
A blue-collar worker such as handyman needs a pickup truck and has all of their tools and supplies inside or outside the car.
Nice cars are needed by those who work in sales roles such as getting to client’s offices or if you’re a real estate agent for showings and open houses.
If you’re a sales role, your clients will perceive how successful you are if you show up in a nicer car like a Lexus Rx 350 for example.
Your clients will think that you’re the most successful agent in the world because you’re able to afford that car.
Status symbol: people with nicer cars are perceived as successful whether it is true or not.
But in reality, maybe the owner is drowning in debts but hey got to have that Mercedes or BMW to look the part and be perceived as successful.
Why are they spending so much money to get you to the car dealership? The answer is that this is a multi-billion dollar industry.
Why is a car so important in today’s society?
Most people cannot afford to pay for their cars in cash so they have to finance it.
You then have to pay interest on that borrowed money. While the car is depreciating in value, you have to fork out a sizable sum to maintain your beloved car.
A new car loses 10% of its value immediately after the purchase of a car.
For luxury car owners, the depreciation number is even higher!
There are all sorts of maintenance that you will need to pay for such as insurance, oil change, new tires etc…the list goes on and on.
You might think that you’ve got this covered because you purchase a warranty upfront.
Yes, that’s true that you don’t have to pay for the maintenance fees, but you used the money to purchase that warranty plan. So you’re still paying.
This is an opportunity cost because you could have used that money and put it in the market and earn better returns. This concept is called the time value of money.
A USA Today article cited that the average car payment is $551 per month for an average duration of 69 months (5.75 years).
Using a compounding interest calculator, that $551 at a 7% return rate can yield $46,443.57 in 6 years.
Final Thoughts on how much car can I afford?
A car is very important in today’s society. But depending on where you live, especially in the big cities, you can get by with other modes of transportation and save a ton of money along the way.
For example, if you live near where you work, you can walk or use a bicycle.
You can also use public transportation to get to work or other locations. However, if you live in a suburb or if you have to commute to work, then a car is unfortunately necessary.
If you need to buy a car, knowing how much car you can afford is very important. The 20/4/10 rule is a good rule of thumb to start.
Most car gurus agree with not exceeding 10% of your take-home pay for a car payment.
Better yet, use cash to pay for your car, preferably a used car that is around 3 years old. Due to depreciation, 3-year-old cars should be at their true price point.
I hope this post provides useful information to you and good luck with your next car purchase.
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Lastly, I remembered that even millionaires don’t pay more than $30,000 for their cars according to The Millionaire Next Door book. Get your copy today here.