How much should you spend on a new car? Not more than 20 percent of monthly income, say experts. And that should include payments on all the cars you own, whether you have one vehicle or six. 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. It's like taking your money to Las Vegas. You are guaranteeing that a big chunk of money will get smaller and smaller, because cars constantly go down in value.
To calculate monthly payments, you should factor in proposed purchase price, the down payment and the 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.
No down payment?Whether you decide to make a down payment will also affect the size of your monthly payment. In the past, you almost always had to make a down payment -- it was 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 eager to sell cars that they don't want the stumbling block of a down payment to stand in the way.
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.
The exceptionsAs you might expect, there are exceptions to the 20 percent rule. One would be a recent graduate who still lives with Mom and Dad. Not having a house payment and probably having a rather small take-home paycheck might justify a larger monthly payment. Also, if one spouse earns far more than the other, the one with the smaller paycheck can easily break the rule.
Other important considerationsAt 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: Car insurance, fuel, maintenance and repairs 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 the run-of-the-mill good old American four-door sedan. 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.
Maintenance is 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 and gas mileage 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 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.
20 percent rule