Deciding how a car fits into your financial life can be tricky. Financial experts have various opinions on the true cost of car ownership. Some suggest limiting total car expenses—including gas, insurance, and payments—to 20% of your pre-tax monthly income. Others propose a car price roughly equal to half your annual take-home pay. Then, some frugal finance gurus recommend spending no more than 10%-15% of your yearly income on the vehicle itself. With terms like pre-tax, post-tax, and annual income floating around, it’s easy to feel lost and ask: “Exactly How Much Car Can I Afford?”
While there’s no magic formula, a helpful guideline is to aim for a new car payment that doesn’t exceed 15% of your monthly take-home pay. If you’re considering leasing or buying used, try to keep it under 10%. This 10%-15% rule is crucial because the monthly payment is just one piece of the car ownership puzzle. Don’t forget to budget for ongoing costs like fuel and insurance, often overlooked. We recommend allocating an additional 7% of your take-home pay for these expenses. Ideally, your total car budget—payment, fuel, and insurance—should remain at or below 20% of your monthly take-home pay.
This 10%-15% guideline might not be a perfect fit for everyone, but it serves as an excellent starting point. It helps you identify a target car price that won’t leave you financially strained each month. To get a more personalized understanding of your car affordability, let’s break down the process.
1. Calculate Your Realistic Car Budget
Take some time to honestly assess your monthly spending. Start with your monthly take-home pay—the money you actually receive after taxes and deductions. Then, subtract your essential monthly expenses: rent or mortgage, utilities, groceries, childcare costs, savings contributions, and regular entertainment spending. What’s left is a clearer picture of how much room you have in your budget for a car payment.
To visualize potential vehicles within your budget, explore online car affordability calculators. These tools, like the Edmunds affordability calculator, can show you vehicles that align with your pre-determined monthly payment range. Remember that the prices you see are starting points. The final price will vary based on trim level, optional features, local sales tax, and registration fees.
Feeling like your budget is tighter than you hoped? You’re not alone. Car prices have generally increased over the years, often outpacing wage growth. The remaining amount after your expense calculations represents your automotive budget. Crucially, this budget encompasses more than just the car payment itself. Let’s move on to estimating fuel and insurance costs, which are vital parts of the overall picture.
2. Factor in Fuel and Insurance Expenses
Before you finalize any car purchase or lease, it’s essential to estimate your ongoing fuel and insurance costs. These expenses can fluctuate significantly based on factors like your location, driving history, and the specific vehicle you choose. While it takes a bit of effort to research these costs upfront, doing so is a smart move. Knowing these figures can be a deciding factor when comparing different vehicles. Some models might be more fuel-efficient, while others could have higher insurance premiums.
For fuel cost estimations, the EPA’s Fueleconomy.gov website is a valuable resource. It provides detailed fuel economy ratings and annual fuel cost estimates for both new and used vehicles. This website allows you to compare different models and see their projected fuel consumption, helping you make an informed decision based on your driving habits and fuel prices in your area.
To get accurate car insurance quotes, contact your current insurance agent or explore online insurance comparison websites. Provide them with details about the specific vehicle you’re interested in (make, model, year) and your personal driving profile. Reputable insurance websites usually offer options to get online quotes quickly. Once you have these estimates, check if the combined fuel and insurance costs fall within that target of 7% or less of your monthly take-home pay. If they do, you’re on track to maintain a healthy overall car budget.
3. Understand Your Car Buying Habits
Beyond affordability formulas, reflecting on your past car-buying behaviors can provide valuable insights into the best strategy for you. Are you the type of person who buys a car, diligently pays off the loan, and then keeps the vehicle for many years afterward? If so, buying a new car could be a good fit for you. Your history shows you’re comfortable with long-term ownership, loan repayment, and enjoying payment-free years. This approach is financially sound and builds equity over time.
On the other hand, do you tend to get restless with a car after just a few years, always wanting the latest model? If this sounds like you, leasing might be a more practical option. Committing to a long six-year loan when you know you’ll likely trade in the car in the fourth or fifth year can be financially disadvantageous. You could end up owing more than the car is worth at trade-in, rolling that negative equity into your next loan and creating a cycle of debt. Leasing allows you to enjoy a new car with lower monthly payments and the flexibility to upgrade more frequently. Leasing can also allow you to drive a more upscale vehicle for the same monthly cost compared to buying.
Finally, if your primary goal is to make the most financially responsible car decision possible, consider buying a lightly used car, paying it off quickly, and keeping it for the long haul. Letting the first owner absorb the steepest part of depreciation—the initial drop in value after a new car is driven off the lot—is a smart financial move. You’ll get a car that’s still relatively new and reliable, minimizing the risk of major repairs in the near future. This strategy maximizes value and minimizes long-term car expenses.
Examining a Typical New-Car Buyer’s Situation
To make these budgeting concepts more tangible, let’s consider a real-world example with some average income figures. According to the U.S. Bureau of Labor Statistics data from the second quarter of 2019, the median weekly earnings for a full-time worker in the U.S. were approximately $908. This translates to an annual income of around $47,216.
Assuming a 20% estimate for income taxes, this worker, whom we’ll call Sarah, would have a monthly take-home income of roughly $3,148. Following our 15% rule for a new car payment, Sarah could comfortably manage a monthly payment of up to $472.
In September 2019, data from Edmunds indicated that the average amount financed for a new vehicle was $32,928. Imagine Sarah decides to purchase a new SUV like a Honda CR-V for this amount. Assuming she has good credit and the loan terms align with industry averages, she makes an 11% down payment, which comes out to approximately $4,075. Opting for a common 72-month loan term, her monthly payment would be around $542.
Immediately, we see Sarah is slightly over budget on her payment alone, even before considering fuel and insurance.
Let’s estimate fuel costs at $120 per month and car insurance at $140 per month. This brings Sarah’s total monthly car expenses to $802, or roughly 25% of her monthly take-home pay.
While some individuals might be comfortable allocating a quarter of their income to car ownership, for Sarah, this level of spending could create financial strain. What if Sarah earned less than the median income? What if she had less-than-perfect credit, leading to higher interest rates? Or what if she was already managing other debts? In these scenarios, buying a brand-new car at this price point could be a significant financial challenge. Sarah’s options would then include considering a less expensive new vehicle, exploring leasing, or seriously looking at the used car market.
Exploring the Used-Car Path
How would the financial picture change if Sarah opted for a used car instead? One immediate benefit is a lower purchase price compared to a new vehicle. Used car financing may also be more accessible to those with less-than-perfect credit. Again, using average figures, let’s say Sarah chooses a used SUV and finances $22,623. A down payment of just over 10% would be around $2,660. With a roughly 68-month loan term, her monthly payment would be approximately $416. Used car loans typically carry a higher interest rate than new car loans, often about 3 percentage points higher, but this is standard in the used car market.
Fuel costs would likely remain similar to a new car. Insurance costs might be slightly lower due to the car’s depreciated value. However, any insurance savings could be offset by potential maintenance costs associated with an older vehicle. For simplicity, let’s assume the combined fuel and insurance costs remain around 8% of her take-home pay, similar to the new car scenario.
By choosing a used vehicle, Sarah’s total monthly car expenses would be around $676, or about 21% of her monthly take-home pay. On the surface, this appears to be a more cost-effective choice, as Sarah is financing a smaller loan amount.
However, it’s important to consider the loan term. A five-and-a-half-year loan means the car will be 8 or 9 years old by the time it’s paid off. How much longer will Sarah want to drive it at that point? Long loan terms can minimize monthly payments but extend the time you’re making payments and delay becoming payment-free. If Sarah plans to buy another SUV as soon as the used car is paid off, leasing might be a worthwhile alternative to consider.
Considering the Lease Option
In 2019, a typical three-year car lease had an average monthly payment of $465 and an average down payment of $2,646. It’s worth noting that these averages are somewhat elevated because lease deals are often advertised for luxury vehicles brands. Since Sarah isn’t aiming for a luxury car, she should be able to find a midsize SUV lease for around $400 per month with a down payment closer to $1,800. One key factor with leasing is mileage limitations, often around 12,000 miles per year for advertised specials. Exceeding this mileage limit incurs extra charges, potentially adding around $25 per month to the cost for additional miles.
Sarah’s lease payment of $400 per month would be a more manageable 12.7% of her take-home pay. Adding the estimated 7% for fuel and insurance, her total monthly car expenses would be approximately $660, or about 21% of her monthly income – just slightly above our recommended 20% target for total car expenses.
In this scenario, Sarah’s monthly lease payment is lower than both the new and used car purchase payments. The smaller down payment also means she retains more cash upfront. However, leasing comes with mileage restrictions and the need to repeat the car acquisition process every three years when the lease ends.
Finding Your Best Car Affordability Option
Each of these approaches – buying new, buying used, or leasing – has potential benefits and drawbacks in terms of affordability. Understanding your personal car-buying patterns and financial priorities is crucial. If you choose a long-term loan, commit to driving the vehicle for several years beyond the loan payoff to maximize its value.
Ultimately, the best car-buying scenario is one that aligns with your overall financial picture, considering all your regular bills and financial responsibilities. Avoid stretching your budget to its absolute limit when choosing a car. If purchasing a car feels financially tight right now, consider saving more and revisiting your car shopping plans at a more financially comfortable time. The most important takeaway is to know your budget limits and remember that car ownership involves more than just the monthly payment.
