Affordability? Stick to 20 percent
By Sylvia
Booth Hubbard • Bankrate.com
How much should you spend on a new car?
Not more than 20 percent of monthly income, say experts. "This
includes payments on all the cars you may own, whether you have
one vehicle or six," says Karl Brauer, editor-in-chief at Edmunds.com.
"And we're talking about your take-home pay, not your gross
income."
Even if your home is paid for and you
have few monthly bills, the basic rule still stands.
"By and large, cars are terrible
investments," says Brauer. "It sounds logical to say that
if you don't have a house payment, you can take that money and put
it on a car, but no financial adviser would think it was wise. Cars
are such a bad investment that it would be like taking your money
to Las Vegas. You would be almost guaranteeing that a big chunk
of money will get smaller and smaller because cars constantly go
down in value."
Calculating payments
To calculate
monthly payments you should factor in proposed purchase price,
the down payment, interest rate and term of your loan. All will
affect how much car you can get for your money. If interest rates
are low, you can buy more car to fit under your monthly payment
limit. You may be able to afford a BMW when interest rates are low,
but that 20 percent may only get you a Honda when rates are higher.
Whether or not you decide to make a down
payment will also affect the size of your monthly note. "In
the past, you almost always had to put down a down payment,"
says Brauer. "It was almost like a down payment was proof you
could afford to buy the car. Now, down payments are almost optional.
Car companies and dealers are so anxious to sell cars that they
don't want the stumbling block of a down payment."
The more down payment you provide, the more car
you can afford and still be under your 20 percent limit -- but
only as far as your monthly payment is concerned. You'll still
be spending more money than you should for an asset that will
constantly decrease in value.
Exceptions to the rule
As you might expect, there are exceptions to the 20-percent rule.
Joe Wiesenfelder, senior editor of cars.com says one exception
would be a recent graduate who still lives at home with mom and
dad. Not having a house payment and probably having a rather small
take-home paycheck might justify a larger monthly payment. If
one spouse earns far more than the other, the one with the smaller
paycheck can easily break the rule.
At the same time, you should keep in mind the amount
you can truly afford and that often depends on more than just
the purchase price: Insurance rates, fuel costs, maintenance,
and repair can play a major role in determining affordability.
Some models, such as sports cars and some luxury
foreign models, cost more to repair than minivans and American-made
cars. "Cheapest to insure is a run-of-the-mill, good old
American four-door sedan," says Jessica Luck, account manager
for Nowogroski Rupp Insurance Group, in Seattle, Wash. "German
and Japanese cars cost more to insure because they cost more to
repair."
Insurance rates can vary widely from model to model.
For instance, insuring a sports car may cost 50 percent more than
a minivan. "You can compare two cars that each cost $20,000
and the insurance rates can vary by 50 percent," says Brauer.
Maintenance is also a factor many people don't consider.
Sometimes, more expensive cars come with free maintenance. A BMW
may cost more than a Honda, but if it comes with full maintenance
for three years, you'll be saving money in an area most people
don't even think about when they're looking at cars. If you factor
in all the costs of owning the car, you may discover you could
buy the BMW for the same actual total cost. And of course, fuel
costs can affect how much a car will cost to run each year.
Although you should keep the 20-percent rule firmly
in mind when deciding which car to purchase, make sure you consider
the other factors that will affect the overall cost of owning
and driving the vehicle. Edmunds.com provides a free
calculator that can help you can obtain an accurate estimate
of the actual cost per mile of driving a car, taking into consideration
such costs as depreciation, interest, taxes and fees, insurance
premiums, fuel costs, maintenance and repairs.
Sylvia Booth Hubbard is a freelance
writer based in Mississippi.
-- Posted: Feb. 15, 2005
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