We always say that buying a new car is all about the preparation. The more you are prepared for your upcoming auto loan and the application process, the smoother it will go. It’s the same for preparing a budget for a new car, down payments and everything else that goes into buying one.
Today we’re concentrating on budgeting. It’s arguably the most important aspect of buying a car as it influences every other decision you’ll make.
We asked our auto loans team to explain how to calculate a budget for a new car purchase. This is what they came up with.
How to Calculate a Budget For a New Car
The math is actually very straightforward. In an ideal situation, your auto loan payment should not be more than 10-15% of your monthly income. The down payment should be between 10-20% of the purchase price and the term of the loan should be as short as possible.
For example, you earn $3,500 per month so your maximum auto loan payment should be no more than $350-$425.
The car you’re looking at costs $30,000 so your down payment should be between $3,000-$6,000. The more the better.
The term should be as short as possible to make the above two work.
If your monthly payment is a maximum of $425 and the car’s value is $30,000 with a $6,000 down payment, you’re looking at a term of around 72 months.
If you could put more money down, say $10,000, the term could reduce to 60 months.
You get the idea.
Auto loan calculators let you pay around with the figures until you come up with something you can work with.
Budget Considerations For a New Car Purchase
Make sure to take each of the following into account.
Total cost of the car: The total cost of the car will include the sticker price plus local taxes, title and registration. Make sure to factor them all in when coming up with a value.
Total cost of the car loan: With all these numbers floating around, it’s easy to become distracted. Make sure to always have the total cost of the loan in mind when working out what you can afford.
That means the total amount you borrow, plus all the interest and any fees for the entire term of the loan.
Monthly interest: This is typically where most of our focus is, as it’s the biggest influence over whether a loan is affordable or not. We should never concentrate on monthly payments and forget about the total cost of the loan.
Monthly payments: The more you can put down the better. But you need to balance waiting for the car while you’re saving with the benefits of driving a new car. This is especially true if your current car drinks a lot of gas or needs frequent repair.
Trade-in value: We didn’t factor in a trade in above because not everyone has one but your current car will have some kind of value even if it isn’t much. Figure out how much it’s worth and deduct that amount from the total cost of the car, or add it to your down payment, whatever works best for you.
2 Rules to Help You Calculate a Budget for a New Car
The 20/4/10 Rule
Some rules are worth following and the 20/4/10 rule is one of them. While we say ‘rule’ it’s more flexible than the usual rules and can adapt to different circumstances.
The 20/4/10 rule is specifically for car loans and says that you should aim for a 20% down payment over 4 years and payments that don’t exceed 10% of your income.
It’s a relatively flexible rule and it doesn’t matter if you exceed that a little but you should avoid going too far over it.
A 20% down payment is a luxury some cannot afford and that’s fine but if you can get close to that, your overall loan will be cheaper each month and much cheaper over the term.
Car loans used to be for 2 or 3 years but those terms slowly expanded alongside the price of cars. As cars, and our aspirations, become more expensive, you have two options. Pay more each month or go for a longer term loan.
Many will elect for a longer term as you can buy the car you want without compromising your monthly budget. However, these loans are more expensive so won’t work for everyone.
The 10% part simply means not spending over that amount in your monthly car loan payment. This again is flexible but a useful rule to bear in mind. With rents and mortgages eating a lot of our income, we don’t want to overburden ourselves with too many outgoings.
The 35% Rule
The 35% rule says that you should not spend more than 35% of your income servicing debt. That debt should include all borrowing, credit cards, store cards, student debt, mortgage and anything else you might have.
This rule goes towards your debt to income ratio that we have spoken about before. The ‘ideal’ ratio is 30% but going over it a little won’t hurt your chances and should still be affordable.
It can be difficult in some territories and even some cities to include rent or mortgage in that amount but it is beneficial if you can make it happen. Housing is a part of that ratio and while rent is viewed differently to a mortgage, it’s still an essential outgoing each month.
While we call these two ‘rules’, you can clearly see they aren’t really rules in the traditional sense. They are more guidelines we can all use to make sure a car loan is affordable and won’t leave us in too much debt. They are too flexible to be true rules but should be borne in mind by anyone considering a new car loan.
If you want to discuss car loans, affordability, credit to income ratios or anything else, contact our team. We are happy to help!
For those of you who know that you have a challenging credit situation, please visit Dixie Auto Loans where we have a team of credit specialists ready to help you get approved for a car loan today!