Creating a Car Budget
Buying a car is a big deal. While it is easy to picture yourself driving a fancy new ride, you shouldn't get ahead of yourself. By knowing what you can realistically afford, you can set a car budget that will help you avoid overpaying for a car and getting yourself into financial trouble.
Where to Start?
Pull out your calculator; it's time to do some math. The first and easiest step in setting a car budget is to determine what your income and expenses are. Remember, you are going to want to base your income on what you actually take home (after taxes) and not your gross pay.
The next, and much more difficult step, is to determine how much you can afford and want to spend on a new car. Just because you can afford an expensive car doesn't mean you should buy one. You may have other priorities to consider, or may want to account for unexpected expenses down the road.
Getting an Auto Loan
Chances are if you are budgeting for a car, you are budgeting for an auto loan. Your primary focus should be on the monthly payments.
The general rule of thumb is that you shouldn't spend more than 20% of your monthly income on your car loan payments—and some even say that is generous.
Much of that budget will be dictated by your personal circumstances. If you already have a lot of expenses—such as a mortgage or rent, student loans, food, etc.—there isn't much you can cut from your budget.
If, on the other hand, you have expenses you can and are willing to cut, like your entertainment or vacation budget, then you can afford more for a car.
Want a better idea of what you'll be paying for your new car every month? Use our Auto Loan Calculator to estimate the monthly payments for the vehicle you want to buy at the interest rate you are expecting to pay.
Unless you are very comfortable with debt, the larger the down payment you can make, the better. It will cost you less in the long run because there will be less interest to pay, for two reasons:
- You will likely get a better deal on the interest rate when making a large down payment.
- There will be fewer total payments to make over the life of the loan.
Additionally, it means you own a greater share of the car. This is an advantage if you need to refinance the loan or sell the car.
Shoot for a 20% down payment if you can. And don't let the “0% down!" offers fool you: they're reserved for people with the very best credit, and often come with other tradeoffs.
Don't Bite off More than You Can Chew
The worst thing that you can do is purchase a car that you can't actually afford. It can be easy to get carried away by the car you think you want and the extras that come with it. However, this can likely lead to:
- Missed payments.
- Repossession of the car.
- Significant damage to your credit.
You should really think through how much you want to spend FIRST— and then don't let anyone talk you out of that budget.
Understanding the full costs of buying a car can make a big difference in your shopping results. It will help you avoid surprises and allow you to negotiate with confidence. The cost of your car can include the following:
- Initial costs:
- Down payment (which can be offset by the trade-in value of your existing car).
- State fees like licensing/registration/title.
- Dealership documentation fee.
- Other miscellaneous dealership fees.
- Recurring costs:
- Monthly car payments.
- Car insurance.
- State registration renewal.
- Potential other costs:
- Traffic tickets.
- Car accidents.
- Various post-sale upgrades or customization.
If you're wise to the bigger picture of vehicle expenses BEFORE you head out the door, you'll end up with a vehicle that is best for you AND your wallet.