If you’re buying a car, the first thing to look at is, “how much car can I afford?”
A new car purchase can be a million-dollar mistake! Before getting your heart set on a car, first determine what you can afford. We’ll dive into car affordability if you’re buying with cash or if you need to finance. Your home and car are two big ticket items you’ve gotta get right. If you buy a home and car you can afford, then everything else with money is WAY easier.
Since I just bought a car, I’ve been posting a ton on social, but here’s a complete guide to car affordability!
How much car can I afford?
The easy answer is you can afford a car you can pay for in full with CASH! There’s a lot of freedom in not having car payments. When you tie a large chunk of your cash monthly to a car payment, you destroy your ability to build wealth. For example, the average new car payment in 2023 is $725. If you invested (vs having a car payment) over 30 years, you’ll have $1,080,000, assuming 8% interest😮.
35% Rule
A common rule of thumb is to buy a car valued at less than 35% of your annual gross income if you’re financing. Or if you’re buying with cash, buy a car for up to 50% of your gross annual income. For example, if you make $50,000 a year, then search for a car with a price of less than $17,500 ($50,000 X .35). Or $25,000 if you’re paying with cash ($50,000 X .50).
The average cost of a new car in 2023 is $48,000. To afford this following the 35% rule you’d need an income of $137,142. For most people, to buy a car you can truly afford it makes sense to look for a good used car (2-5 years old).
Look at the total purchase price.
When determining your car budget look at the total car purchase price with fees. This is known as the “out the door cost.” Dealers advertise the car sales price and sometimes try to add other unnecessary fees. Most fees you can avoid paying, but there are three other costs you can’t avoid when buying a car.
- Sales tax- depends on your city, county, and state. The average sales tax is 5.5%.
- Registration and title fees- the cost in your state to title and register with the Department of Motor Vehicles. The average fee is $51.57.
- Documentation fees- required fee to prepare the contract and sale of the car. These vary by state and range from as low as $75 up to $995.
These fees can add thousands to the total cost. Estimate the fees ahead of time to avoid sticker shock.
Current average new car cost over the life of the loan.
Let’s take a look at how much a new car will cost over the life of a loan with current stats. The average interest rate on car loans in the first quarter of 2023 was 6.58% for new cars and 11.17% for used cars. Lending Tree reported the average car loan term in 2023 is 68.6 months for new cars and 67.4 for used cars. This is almost six years!
With the average new car price of $48,000 an estimated total out the door price is around $51,344. This assumes a 6.25% sales tax ($3,000) and $344.73 in doc fees, title, and registrations.
With around $10,300 down, the average term of 68 months, and rate of 6.58% over the life of the loan you’ll spend $8,237 in interest or $59,581 total.
Unfortunately, when the car is finally paid off it will be worth a fraction of the original cost. Cars are depreciating assets, meaning the value dramatically declines rapidly. Carfax estimated new cars lose 20% of their value in the first year and continue to decline about 15% every year after.
After 68 months this car is now worth between $17,000- $20,000. You lose almost 70% of your money!
How to buy a car with cash.
It may seem impossible to outright buy a car with cash, but the basic process I recommend is to turn a liability into an asset.
A liability is what you owe (like your car loan and monthly payment), and an asset is what you own (like a paid for car or savings/investments). When you finish paying off your current car, what was once a liability and obligation (your monthly car payment) will now be your biggest asset. Use this money to save monthly on your next car.
For example, if you have a monthly car payment now of $500, once you pay off your car, pretend like you still have this monthly payment. Instead of immediately trading in your current car for something newer, continue to drive your car.
Save the $500 into a high yield savings account and within 35 months you’ll have $17,500 to buy your next car outright.
This assumption doesn’t take into consideration your savings will earn interest (rates are now above 4%) and you’ll be able to sell your current car to put down on your next car purchase.
Obviously, you need to plan ahead to buy with cash. If you get in a car accident and suddenly need a car or can’t purchase it with cash, then here’s some guidelines if you take out a loan for a car.
Best Money Class Ever student, Kim paid off all her debt (45K) in 28 months and later bought a Tesla with cash!
20-4-10 Rule
If you’re financing, then a general rule of thumb for car affordability is the 20-4-10 rule.
20% Car Down Payment
This rule of thumb recommends putting at least 20% down on your car (including money made from the sale of your previous car). For example, if you’re financing a $17,500 car then a 20% downpayment is $3,500.
Having a down payment will help make sure you’re not underwater or owe more than your car is worth. Also, the less you borrow, the less you’ll spend on interest.
Four-Year Term
If you’re financing a car, then select a car loan of 48 months or less. Obviously, the appeal of spreading your payment over a longer period is you’ll have lower monthly payments. You can usually drive a newer and nicer car with a longer term. As tempting as this is, it doesn’t make financial sense to borrow long-term on a depreciating asset.
10 % Monthly Payment
Lastly, with this rule of thumb, the ten is for your monthly payment. NerdWallet recommends your monthly payment for a car is less than 10% of your take-home pay. For example, if your take-home after taxes and deductions is $4,000, then you’ll want a car payment of $400 ($4,000 X .1) or less.
You can use an online calculator (like this one) to estimate how much the car payment will be.
All in all, it’s very important to buy a car you can afford! Start planning ahead now for your next car purchase.
❤️ Carly
Ready to get your finances in order? The Ultimate Guide to Managing Money, my free class and the intro to Best Money Class Ever is starting soon. Stay tuned for details.
