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Because most car buyers finance their purchase and pay a monthly car payment, the amount you spend on the car must fit into your overall budget. You will need to consider many factors when deciding what is affordable for you. For example, you should take into account financing costs and interest rates, the down payment and trade-in allowance, and, of course, other debt.
Your Monthly Budget
Your car payment is probably not the only large monthly payment you have. In addition to what you spend on a car, you might have rent or a mortgage, insurance, and taxes. Many families try to limit their debt payments (loans) to 45% or less of their monthly gross income.
For example, if your entire household earns $5,000 in gross wages every month, then your budget might be 24% for the mortgage, or $1,200, leaving about $2,550 in cash after income taxes. Because you still need to have money for insurance, groceries, fuel, and other household expenses, a reasonable car budget would be 20% of your gross wages, or $1,000 per month. Your challenge is to find two cars you can finance for no more than a total of $1,000 per month.
Some people don't have the usual household expenses. If you are single and live with your parents, then you can afford to spend a larger portion of your income on car payments. Someone with a monthly salary of $2,900 and minimal household commitments could spend 30% of your gross income on a car payment. Imagine the possibilities if you were spending $870 per month in car payments?
For most of us, the budget amount allocated to car payments has to include insurance and registration fees so you don't get caught short at the DMV. If you are buying a used car, you might also want to earmark a small amount of monthly funds for repairs and maintenance.
You will find that by analyzing your monthly budget and being honest about your other financial commitments, you can identify the car payment that is affordable for you.
Calculating the Total Price
Knowing what your monthly budget is will give you only half of the picture. You still need to figure the total price you are willing to pay. If you go to the car dealer with a monthly budget, they can make almost anything work by extending the term of your loan.
Before you negotiate or even consider financing options, you will have to settle on the price range you're comfortable with. The price you pay will depend on several variables:
- Rebate programs
- Trade-in allowance
- Down payment
- Application fee
- Financing term
Because your monthly payment is calculated on the total price paid, the loan term, and the interest rate, you will want to keep the initial borrowed amount as small as possible. Strike a good deal and make use of incentives if they help you to lower the total amount borrowed. In the end, a shorter term will mean higher payments each month but less interest over the life of the loan.
What is affordable for your monthly budget is tied directly into the deal you craft on the total purchase price. Knowing what your maximum allowance is before you begin your car search will help you to stay on target.
Buying a car without a budget is frustrating because there are so many price ranges to look at―you could spend days and days looking at cars. And the risk of getting yourself into something that isn't affordable for you is greater if you start shopping without a budget.