Most lenders and financial consultants agree that you should never commit more than 20 percent of your gross monthly income on a car. This includes not just your car payment, but other expenses such as:
As for your payment itself, money experts have suggested an amount equivalent to 8-10% of your monthly income. The average in the United States is 11%, which is a bit too high. You need to leave plenty of room in your budget for the additional expenses listed above. If you have multiple cars under your family umbrella, then you should use spend no more than 20% of your household income on all vehicles combined.
Don’t Forget Debt-to-Income Ratio
Twenty percent of your income is quite a chunk to spend, but cars are expensive, and your budgeting doesn’t stop there. Another factor to keep in mind is that lenders want to see that all of your monthly payments combined account for less than 40% of your monthly income. This is your debt-to-income ratio, or DTI. If it’s too high, you may be faced with higher interest rates, smaller loans, and even outright rejection of your loan. For this reason, it’s not a bad idea to pay some of your debt before buying a car.
Considering The “True” Cost of Ownership
Being able to spend twenty percent of your income on a car payment sound goods, but do not forget the other expenses related to owning a car. You need to factor in insurance premiums, fuel, scheduled maintenance, even parking if you live/work in a large city. These expenses along with the monthly payment on a vehicle are called the true cost of ownership. Edmunds.com offers a great tool to help you figure the true cost of owning the vehicle you are looking to buy at this link: http://www.edmunds.com/tco.html
6-Month Strategy for Determining What You Can Afford
Alright, now you know that twenty percent is the rule, can you afford that much? The easiest way to tell is to spend it. Well, not on a car loan, but into your savings account. Starting with your next paycheck, deposit twenty percent of it into your savings account. Do that every pay period for six months. If you can leave the money sit throughout that period, then you can afford to commit that much to a vehicle. As a nice bonus, you will have built up a considerable down payment, making your next car even more affordable. If not, try stepping it down somewhat. Maybe 10% is more affordable.