How to Determine How Much
Car You Can Afford
Another tip brought to you by:
Your number 1 source for advice on
car buying, car selling, and car owning.
Before you do any research on a new or used vehicle you need to determine how
much you can afford to spend. The general rule of thumb is that your monthly
payment should not exceed 20% of your monthly take home pay (not your gross
income). This rule applies to car payments as a whole. If you are making payments
on two vehicles, the total of the payments for both vehicles should not exceed 20%
of your monthly net income.
Knowing how much car you can afford is very important because it could prevent
you from becoming upside-down on your loan -- meaning you owe more than the
vehicle is worth. According to Edmunds.com, almost 25% of Americans are
upside-down on their auto loans, with an average of $4,442 in negative equity.
Being upside-down can really hurt you when you go to purchase your next vehicle
because many people sell or trade in vehicles they own and use that money as a
down payment on their next car.
To calculate monthly payments you need to know total purchase price (including
taxes and registration), the down payment, interest rate and term of your loan. If
you are having difficulty staying in that 20% range you have options. You can
increase your down payment, thus decreasing the amount of your loan. A $20,000
loan for 4 years at 5.5% interest will cost you $465 a month. If you are able to add
$2,000 to your down payment your monthly payment will drop by almost $50.
A way to increase your down payment is to sell your vehicle on your own, rather
than trade it in. Another option to keep your payments down is to request a loan
with a longer term. Extending that $20,000 loan at 5.5% interest from 4 years to 5
years will shave over $80 off your monthly payment. Extending it to 6 years will
take another $47 off your monthly payment. One thing you need to keep in mind if
you are considering this is th