Leather interior. Rearview cameras. Automatic emergency braking. While you may dream of a shiny new car with all these features and more, you may need to prepare for sticker shock.
The average new car costs more than $40,000, and used cars average above $21,000. Of course you can buy a brand new car for as little as $16,000 and decent used cars can be picked up for a few thousand. What this means is that you have to think about your needs, budget, and other financial priorities. Then decide how much you can and wish to spend to meet your transportation needs. Whether it’s a used or new vehicle, we’ll try to make the decision easier for you.
How to Calculate How Much You Can Afford to Spend on a Car
When thinking about what you should spend on a vehicle, you should keep in mind that the purchase price is only one part of your expenses.
To make sure you can comfortably afford the car you want, make sure you account for the following:
1. Income
Calculate your take-home income. This is how much you earn after taxes. 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, you should spend $400 to $600 on transportation.
To be sure, that range is simply for guidance. Depending on your income and expenses, you may have to budget less. For example, if you live in an area with high housing costs, you’ll have less to spend on a car.
2. Existing Debt
If you have debt like student loans, medical bills, or credit card balances, your payments may eat up a big part of your income. Lots of debt will trim that car-buying budget.
3. Financing
You may choose to finance your purchase with a loan. More than 81% of new cars and 34% of used cars are bought with car loans, according to recent data.
When you apply for a loan, lenders review your application and credit score. Once your loan is approved, the interest rate will be set. The rate, based on your credit score, helps determine your repayment amount.
Your interest rate affects both your monthly payments and total repayment costs—a lower rate means you will spend less over the life of the loan.
As of 2020, the average interest rate on a car loan is 4.31%, but borrowers with poor or subprime credit could pay as much as 21%.
4. Taxes and Fees
When you buy a car, the purchase price is only part of your total layout. You’ll also pay fees and, in most states, taxes:
- Sales tax: If your state charges sales tax, you’ll pay that on the purchase price minus any discounts and trade-in allowances. A handful of states don’t tax car sales.
- Registration fee: You must register your vehicle. Registration fees can range from $30 to $50.
- Tag and title fee: You will have to pay for the title and license plates for your vehicle.
- Documentation fee or dealer fee: In some states, documentation or dealer fees are common. These fees are in addition to the other costs and vary by location.
To demonstrate how those expenses can add to your total cost, consider an example. If you bought a $30,000 car in Florida, you’d pay the following:
- Sales tax: $1,800 (6% sales tax)
- Initial registration fee: $225
- New title fee: $77.25
- Original license plate fee: $28
- Dealer fee: $399 (varies by location)
TOTAL: $2,529.25
5. Car Insurance Premiums
Drivers are required to carry liability insurance in nearly every state. However, most drivers also opt for collision and comprehensive coverage for extra protection.
The average U.S. car insurance policy costs $1,483 per year or about $124 per month. Your premiums are dependent on the type of car you own, your age, driving history, location, selected coverage options and the number of miles you expect to drive.
Remember that the kind of car you drive affects the amount of insurance you pay. New, more expensive cars usually cost more to insure, while exceptions to this rule do exist.
6. Maintenance Fees
While you may not be thinking about repairs on a new vehicle, all cars need maintenance. If your car is older, it may need a tune-up or new tires.
In general, maintenance costs about 9 cents per mile. If you drive $12,000 miles per year, you should expect to spend $1,080 on maintenance annually.
7. Fuel
If you commute to school or work, gas is another expense to add to your budget. The average person spends $2,094 per year on gas, or $174.50 per month. However, if you have a lengthy commute or enjoy road trips, your actual cost may be much higher. To add money back to your budget, buy a car with a smaller motor that burns less fuel.
Deciding Your Budget
Using the information, here’s an example of how to create a budget for buying a car. For this example, we rolled the cost of tax, title, and fees into the purchase price of the car.
If your take-home pay is $4,000 per month and you follow the 10%-15% guideline, you’ll spend as much as $600 a month on transportation. After subtracting the cost of your insurance and setting aside money for maintenance, that leaves you with $464 per month to use as a car payment.
Assuming you have good credit and a small amount of existing debt, you could qualify for a loan with a 60-month term and an interest rate of 5%. With those terms, the most you could afford is $22,000; that would give you a monthly payment of $451 per month.
Buying a Car
Once you find a car that fits your needs and your budget, you can negotiate with the dealer for the best price. Before heading to the dealership, secure financing ahead of time so you can shop around and find the best deals — and have more negotiating power while completing the deal.
An auto loan calculator can help you determine what interest rate and loan term you can afford.
Article By: Kat Tretina
Source: Investopedia