When it comes to buying a car you have the freedom to spend as much as you want – as long as it is within your means.
However, it is important to minimize your loan costs and make sure that the amount you spend on a new car doesn’t undermine your ability to pay other monthly expenses.
So, how much should you spend on a car?
Assuming you are financing the car you’re about to buy, there are two main factors you should be aware of:
The down payment: this is the amount you are paying up-front in order to receive the car.
The monthly payments: this is the amount you pay in monthly installments.
Firstly, while you may be enticed to pay a small down payment, say 5 percent, you may want to reconsider.
The more you pay in your down payment, the less you’ll be losing in the run – lowering the cost of your loan.
A higher down payment cuts how much you’ll be spending on monthly payments, the amount you will borrow, and the amount of interest you’ll pay.
Therefore opt for a high down payment, of at least 20 or 30 percent – or as much as you can.
Now comes the question of how much should you be paying for your car on a monthly basis. A good rule of thumb is not to spend more than 35% of your gross income on total debt payments (gross income is your pay before taxes and social security are deducted).
For example, let’s assume there is someone who earns $100,000 per annum, who currently has $25,000 of total debt payments (yearly), who wants to buy a car.
Thirty-five percent of his salary (of $100,000) is $35,000. However, they already have debt payments that add up to $25,000, so there is $10,000 left for other debt payments – which they can use for car payments.
With $10,000 to spend on monthly car payments per year, the person in the example above should look to be spending no more than $833 per month (10,000 divided by 12) on a car.
Other costs to be aware of when buying a car
Other factors to be aware of when calculating how much to spend on a car include: sales tax, registration fees, insurance premiums, maintenance fees, and gasoline costs – be aware of the car’s gas mileage and how many miles you estimate to be driving.