How do you determine what price point is right for you?

Quick notes

  • How much you can and should spend on a car also depends on your intended usage of the car.

  • Leasing should also be considered, but do research to ensure this is the right option for you.

Before you start car shopping you should figure out what your budget is. A car purchase involves not just the purchase price, the cost of taxes and registration, and insurance, but also parking and gas. These are reoccurring expenses often not figured into auto budgets before purchasing a car.

If you are borrowing the money to purchase the car, you should try to obtain the loan first. When you obtain the loan first you can determine what you can afford to buy, then figure in your calculations of what you SHOULD buy. It’s not necessarily wise to spend your entire available budget.

Formulas to determine how much you should spend

Experts don’t agree on what the perfect number or percentage is in terms of budget allocation. The appropriate budget for you is likely a blend of these formulas.

15% Rule

One of the conservative budget calculations claims a car budget should be no more than a 15% allocation of net pay. This 15% includes insurance, gas and the actual car loan payment.

15% is a conservative calculation and may not be realistic for someone who spends a lot of time in their car. Budgets in this range may benefit from looking at cheaper leasing prices.

36% Rule

A more realistic budget calculation is the 36% rule. The rule advises that you spend no more than 36% of income on debt payments. This means that your car budget may end up being much lower than 36%.

Experts don’t agree on what the perfect number or percentage is in terms of budget allocation. The appropriate budget for you is likely a blend of these formulas.

The lender uses this same calculation in approving car loans. 36% is the magic debt percentage at which you can obtain an auto loan. A higher debt load and you may still get financing, just at a much higher interest rate.

50% Rule

The most liberal car budget calculation is the 50% rule, that you can spend half your income on a car purchase. This is quite a lot, but if you are making a one-time purchase to commute or start a new job, or if your situation allows it (for example, you have roommates and your rent is very low), it may be worthwhile to invest the money in paying off the car in 1 or 2-years.

Doing something like this allows you to afford a more expensive new car or a great second-hand luxury car. This doesn’t allow a lot of room for emergencies, so make sure if you allocate 50% of your income to a car purchase, you have an ample emergency fund in reserve.

20/4/10 Rule

An older calculation used to determine the amount of car you can afford is the 20/4/10 rule. A 20% down payment, on a 4-year car loan, with payments of no more than 10% of your annual income. Improvements in car-part reliability have led to suggestions this is now the 20/5/10 Rule.

Other things to consider when determining your new car budget

Ensure you have calculated your other monthly expenses before buying a car. These costs are often low monthly, but grouped along with others, they can eat away hundreds of dollars a month of your disposable income, making that new car just slightly less affordable.

Pixabay

If you have more than one car or are in the market to make a second purchase over the next few years, these expenses should be factored into your budget. What may seem affordable now, doesn’t mean it will be affordable next year when you need to purchase a new second car.

Additionally, If you are taking on an auto loan in order to purchase your new car, it is a good idea to take a look at future expenses or income decreases which may affect your ability to make the same car payments in the future.

Getting the most car for your budget

Remember that the car salesman’s job is to get you into a car. Don’t tell the salesman what your maximum budget is. See what kind of incentives the dealership has to offer. Here are some other helpful tips:

Obtain affordable financing early – The better the financing rate, the better the car you can afford to buy. The interest rate will be lower and more of your payment will go towards the car.

Take advantage of dealer incentives – Shop around for the best deals. Maximize your budget by looking for the best deal possible.

Look at leasing options – It may be cheaper to lease than purchase, especially if you drive shorter distances. Consider leasing for cheaper monthly payments.

Make credit score improvements – If you know that you will soon be in the market to purchase a new, or newer, car, you should start making efforts to improve your credit. Credit improvement tips can be found for free online.

It may be cheaper to lease than purchase, especially if you drive shorter distances.

Consider a certified pre-owned vehicle – Instead of purchasing a new car, look at certified pre-owned vehicles that often come with dealer warranties and have passed an extensive inspection process. You may be able to avoid making payments if you can instead use your down payment to purchase the car outright.

Provide a larger down payment – If you want to commit less of your monthly income to car expenses, try providing a larger down payment.

A deeper dive — Related reading from the 101:

-Do you know when is the best time to buy a car? | Finance101

Get the most car bang for your buck by buying your car at the right time. 

-Wanna get the best new car price? Shop for the loan, then the ride | Finance101

Review these tips to find out how to get the best price on a new car.