Deciding how much you can comfortably spend on a car is a crucial step in the vehicle purchasing process. Financial experts often offer varying advice, creating confusion for potential car buyers. Some suggest limiting total car expenses—including gas, insurance, and payments—to 20% of your pre-tax monthly income. Others propose that a car costing half your annual take-home pay is a reasonable benchmark. More frugal advisors recommend capping vehicle purchases at just 10%-15% of your annual income. With terms like pre-tax, post-tax, and annual income floating around, it’s easy to feel overwhelmed and ask the fundamental question: “How much car payment can I afford?”
While there’s no single perfect formula, a practical 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, targeting 10% or less is even wiser. This lower percentage accounts for the fact that the car payment is just one piece of the financial puzzle. You also need to budget for fuel, insurance, and often overlooked maintenance costs. Ideally, these additional expenses should fall within another 7% of your take-home pay. Therefore, your total car budget should ideally remain at or below 20% of your monthly take-home income.
This 10%-15% guideline serves as a solid starting point, helping you identify a price range that prevents financial strain each month. To refine this estimate and arrive at a more personalized figure, consider the following steps.
1. Calculate Your Comprehensive Automotive Budget
Begin by meticulously reviewing your monthly spending. Start with your monthly take-home pay and subtract essential expenses: rent or mortgage, utilities, groceries, childcare costs, savings contributions, and entertainment spending. The remaining amount provides a clearer picture of your discretionary income and, consequently, how much you can realistically allocate to a car payment.
If you’re unsure what types of vehicles fit within your budget, utilize online affordability calculators. Resources like the Edmunds affordability calculator can display vehicles within your pre-determined price range. Remember that the prices shown are base estimates and will adjust based on trim levels, added options, local sales tax, and registration fees.
Feeling like affordability is a stretch? You’re not alone. New car prices have risen significantly in recent years, outpacing wage growth for many. This calculated amount represents your broader automotive budget, encompassing more than just the monthly car payment. Next, let’s factor in fuel and insurance costs.
2. Determine Your Anticipated Fuel and Insurance Expenses
Before committing to a purchase or lease, proactively estimate your fuel and insurance costs. These expenses can fluctuate considerably based on your location, driving history, and the specific vehicle you choose. While estimating these costs requires some upfront effort, it’s a crucial step to avoid budget surprises. Understanding these expenses can be invaluable when comparing different vehicles, as some models may be more fuel-efficient or have lower insurance premiums.
The EPA’s Fueleconomy.gov website is an excellent resource for detailed fuel economy ratings and annual fuel cost estimations for both new and used vehicles.
For accurate insurance quotes, contact your current insurance agent or explore online insurance providers. Most insurance websites offer online quote tools where you can input vehicle details and receive an estimated premium. Ideally, combined fuel and insurance costs should remain at or below 7% of your monthly take-home pay to stay within the recommended 20% total car expense budget.
3. Examine Your Car Buying and Ownership Habits
Beyond affordability formulas, reflecting on your past car-buying behaviors, both positive and negative, can offer valuable insights for your next vehicle purchase strategy.
Are you the type to buy a car, diligently pay off the loan, and then keep the vehicle for many years afterward? If so, purchasing a new car could be a suitable approach. Your history demonstrates responsible financial habits, loan completion, and enjoying payment-free ownership.
Alternatively, do you tend to desire a new car every few years? Leasing might be a more financially sound option for you. Committing to a lengthy six-year loan when you’re likely to trade in the vehicle in the fourth or fifth year can lead to owing more than the car is worth and rolling that negative equity into subsequent loans. Leasing offers lower monthly payments and allows you to drive a newer, potentially nicer car for less money in the short term.
Finally, if your primary goal is the most financially prudent decision? Purchasing a lightly used car, paying it off swiftly, and keeping it for an extended period is often the most economical path. The first owner absorbs the steepest depreciation, and you benefit from a relatively new car that should require minimal repairs for several years.
A Real-World Example: Calculating Car Affordability
To make these budgeting concepts more concrete, let’s consider a hypothetical scenario using real-world income figures. In the second quarter of 2019, the median weekly earnings for a full-time worker in the U.S. were $908, according to the U.S. Bureau of Labor and Statistics. This translates to an annual income of approximately $47,216.
Assuming a 20% income tax rate, this individual’s monthly take-home pay would be roughly $3,148. Applying our 15% rule for car payments, this person could comfortably manage a monthly car payment of up to $472.
In September 2019, the average amount financed for a new vehicle was $32,928, according to Edmunds data. Let’s imagine this individual purchases a new Honda Pilot at this average price. Assuming solid credit and average deal terms, an 11% down payment (approximately $4,075) and a common 72-month loan term would result in a monthly payment of $542.
Immediately, we see that the monthly payment exceeds our $472 guideline, and we haven’t yet included fuel and insurance expenses.
Estimating $120 per month for fuel and $140 per month for auto insurance, the total monthly automotive expenses rise to $802, or 25% of the monthly take-home pay.
While some individuals might be comfortable allocating 25% of their income to car ownership, in this scenario, it could create financial pressure. For those with lower incomes, less-than-perfect credit, or existing debt obligations, purchasing a new car at this price point becomes even more challenging. The viable options then become exploring less expensive vehicles, considering leasing, or opting for a used car.
Exploring the Used Car Advantage
How would the financial picture change if our hypothetical buyer considered a used car? Used vehicles typically have lower sticker prices than comparable new models, and financing may be accessible with less stringent credit requirements. Assuming our buyer chooses a used vehicle and aligns with average used car financing data, the amount financed might be around $22,623. A down payment of just over 10% ($2,660) and a 68-month loan term could result in a monthly payment of $416. Used car loans typically carry slightly higher interest rates than new car loans, often around 3 percentage points higher, which is reflected in these figures.
Fuel costs would likely remain similar, and insurance costs might be marginally lower due to the car’s depreciated value. However, potential savings on insurance could be offset by increased maintenance costs associated with an older vehicle. For simplicity, let’s assume fuel and insurance costs remain at the same 8% of take-home pay as with the new car scenario.
By choosing a used vehicle, the total monthly car expenses would be approximately $676, or about 21% of the monthly take-home pay. From a purely payment perspective, this appears more cost-effective due to the smaller loan amount.
However, the loan term extends to five and a half years, at which point the car will be 8 or 9 years old. Considering long loan terms is important because the ultimate goal of financing is to eventually become free of car payments. If the buyer intends to purchase another SUV as soon as the used car loan is paid off, leasing could be a more strategic option.
Considering the Lease Option
In 2019, a three-year car lease averaged a monthly payment of $465 with a down payment of $2,646. It’s important to note that these averages are influenced by the inclusion of luxury vehicles in lease data. For a non-luxury midsize SUV, a lease payment closer to $400 per month with around $1,800 down might be achievable. A key consideration with leasing is mileage limitations, often around 12,000 miles per year in advertised lease specials. Exceeding this mileage limit incurs additional costs, estimated at around $25 per month for each increment of extra miles in our example.
With a $400 monthly lease payment, the expense drops to a more manageable 12.7% of the take-home pay. Adding the estimated 7% for fuel and insurance, the total monthly car expense becomes approximately $660, or about 21% of the monthly income. This is slightly above our recommended 20% threshold for total auto expenses.
In this scenario, leasing results in a significantly lower monthly payment compared to buying new or used. The smaller down payment also leaves more funds readily available. However, leasing comes with mileage restrictions and necessitates repeating the car acquisition process every three years when the lease concludes.
Determining the Optimal Approach for You
Each of these vehicle acquisition methods—buying new, buying used, or leasing—presents a viable path to car ownership, each with its own set of financial implications. Understanding your personal car-buying history and financial habits is paramount. If you opt for a long-term loan, commit to driving the vehicle for several years beyond the loan payoff period to maximize its financial benefit.
Ultimately, the most effective car-buying strategy aligns with your overall budget and financial responsibilities. Avoid stretching your budget to its absolute limit when choosing a car. If purchasing a car feels financially strained right now, consider postponing the purchase, saving more diligently, and revisiting your options when you’re in a stronger financial position. The most critical step is to establish a clear budget and remember that car ownership entails more than just the monthly payment.
