When you purchase a vehicle, there is much more to consider than the purchase price. Along with the monthly payments, you are going to have to pay for insurance and be prepared for all maintenance and repair costs.
Vehicle Price as a Percentage of Income
To address the simplest aspect of the question, the total purchase price of a vehicle should be 35% of your yearly income or less. So, if you make $40,000 per year, you should try to buy a vehicle that costs $14,000 or less. Some financial experts have recommended even lower percentages, from 10-25%, though, depending on your income, these can make it difficult to acquire a reliable vehicle that won’t give you mechanical problems down the road. The reason you want to keep your outlay to a minimum is simple: cars are a bad investment. They don’t hold their value well, and they cost more in terms of maintenance as they age. For these reasons, you want to eschew the impulse to buy the fanciest car on the lot, and instead opt for a modest, reliable, utilitarian vehicle that fits your needs and budget.
Monthly Payment as a Percentage of Income
You also need to consider your monthly payment. Overall, you want to devote no more 10% of your monthly income toward a car payment. In reality, 5-8% is even more preferable. This leaves you plenty of room to pay for gas, repairs, insurance, and not overburden your finances with an expensive vehicle loan.
The Role of Debt-to-Income Ratio
When you attempt to get a loan for your new vehicle, lenders will look at all of your debt payments and compare them to your gross income. This is called your debt-to-income (DTI) ratio, and it includes everything from your rent and utilities to the payments on the loan you are applying for. Your car insurance is another factor considered in your DTI. The vast majority of lenders will deny any loan if the applicant has a DTI that exceeds 40 percent. Lenders consider your credit score when determining what DTI you may have and still get a car loan from them. If your score is in excess of 720, you will have the ability to stretch your DTI to 40 percent. If your score is under 699, you will be required to have a lower DTI. The lower your credit score goes, the lower your DTI will need to be.
There are some online lenders who are willing to take the risk of making loans to people who have a low credit score and a high DTI. A careful search will pair you with a reputable lender who is willing to consider more than your DTI and credit score.