You’re thinking about buying a car, but you don’t know how much you can really afford. Answering how much you can afford, like many other things in the financial world, is easier said than done. Here are some ideas to get you started.
Base it On Your Current Budget
Often “rules of thumb” are tossed around when answering this question. One popular rule of thumb is, don’t spend more than 10% of your take-home pay on a car payment. While that might be a starting point for someone without any other debt and an average income, it won’t make sense for others.
Do this instead:
- Write down your income after taxes
- Subtract all your expenses that are fixed every month such as your water bill, Netflix subscription, electric bill, cell phone bill, and even groceries. Whatever is left over is your discretionary money. Include your car insurance but leave your existing car payment out at this point, if you have one.
- From your discretionary money, do you have any that you should be saving, whether for emergencies or retirement? If so, subtract that amount.
- Consider whether you plan to have any large financial changes in the next couple of years. Do you plan on having another child or buying a house? If so, try to estimate what that might cost every month. Subtract it from the leftover discretionary money.
- Look at the leftover discretionary money and decide how much of it you’d be willing to devote to a car payment. Maybe you’re willing to devote all of it. If that’s the case don’t plan on eating out, grabbing coffee, or anything else extra. Most people like to keep a little buffer.
The amount you come to after doing this exercise is what you may be able to afford.
From there, work backwards. Use an online calculator such as Auto Smart to figure out how much of a loan would match up with that payment.
Knowing your budget is key when purchasing a vehicle. No matter where you end up getting financing, always make sure to keep your budget in mind so you don’t stretch yourself too thin. What lenders look at when determining what you are approved for most often does not take into account lots of our fixed expenses which is why knowing your budget is paramount.
Just because you were approved for it doesn’t mean you need to use all of it.
A Longer-Term Loan Means You’ll Pay More Interest
Longer-term loans come with lower monthly payments than shorter term loans. For instance, a $20,000 60-month loan with 5% Annual Percentage Rate (APR) would cost you about $377 per month. Increase that to 84 months and you’ll pay only $283 a month.
While the monthly payment is lower, increasing the loan by 24 months means you’ll pay an additional $1,100 in interest alone.
Don’t Forget the Other Up-Front Costs
There are other costs associated with buying a car beyond the loan itself.
Sales tax: Depending on where you buy the car, interest will range between 5% to 11%, and may include state, county and local taxes. Click here and select the Motor Vehicle Sales/Rentals tab to search the Total tax rate for vehicles based on your address.
Registration fees: Estimate these fees by using your state’s department of motor vehicles site. You can use the WA State Department of Licensing’s website.
Documentation fee: Can be up to $150 in Washington State.
We’re Here to Help
If you have questions about what auto loan terms make the most sense for you, schedule a meeting with a WECU Loan Officer today.