Calculate: How Much Car You Can Afford With Your Salary?

If you’re in the market for a car and want to know how much car you can afford with your salary, please don’t go to a car dealership until you read this post 🙂 Buying a car should improve your life, not bring financial problems and stress. In this article, we are going to cover (to see the video please scroll down):

• How to calculate the total cost of car ownership
• The 5 main factors that impact your car loan monthly payments
• A few simple formulas that will help you pick the right car, one that won’t make you go broke
• I will also share a simple car affordability calculator. You will be able to see exactly how much car you can afford with your salary.

Because, the last thing you want is to become “car poor,” which, according to Urban Dictionary, means:

“Car Poor”

Having an insanely high car payment that prevents you from doing anything that costs even a minuscule amount of money and prevents you from eating anything other than top ramen.

How Much Car You Can Afford With Your Salary? – watch the video.

In this video I explain how to calculate how much car you can actually afford based on your salary. What is the maximum car loan amount and the maximum monthly payment you can afford without becoming a car poor.

How to Calculate the Total Cost of Car Ownership

With today’s market, we have very high interest rates that affect monthly payments. But, as if that was not enough, there is one thing that many people forget to consider before going to a car dealership. The truth is, your monthly payment will never be the real cost of car ownership. Because as soon as you buy a car, you will have a lot of ongoing car expenses every month. And if you want to understand how much car you can afford with your salary, you need to have an estimation of how much you will spend on transportation every month. Let me give you an idea.

Your total transportation costs or car ownership costs will include:

• Gas – which depends on how often and how far you drive, and also on the car, because different cars have different fuel efficiency. It’s important to consider this before choosing a car. Do you want a car that gets 30 Miles per Gallon or 15 Miles per Gallon?
• Insurance – this can be as much as $150 or $170 a month or even higher.
• Maintenance – this includes oil changes, tire rotations, brake inspections, fluid checks, and other routine services. Sure, they don’t happen every month, but we need to budget for them.
• Repairs – from time to time, things get broken and need to be fixed. And it’s hard to estimate exactly how much you will spend, but it’s safe to say that you will spend more on fixing a Mercedes or Porsche than on fixing a Toyota or Honda. The same goes for maintenance and insurance: the more luxurious the car, the higher the costs.
• Registration and taxes – depending on where you live, you will have certain registration fees and taxes to pay.

So, all these expenses (gas, insurance, maintenance, repairs, registration, and taxes) can easily amount to as high as $300 or $500 a month or even higher. And finally, an important component of car ownership costs is the monthly payment – unless you buy a car in cash, obviously.

5 Main Factors That Impact Your Car Loan Monthly Payments

Understanding how much car you can really afford involves knowing what influences your monthly payments. Here are the 5 factors that impact your monthly payment:

1. Loan Amount – The smaller your loan amount, the smaller your monthly payment.
2. Interest Rate – The lower your interest rate, the lower your monthly payment.
3. Loan Term – The longer your loan term, the lower your monthly payment, but you’ll end up paying more in interest. Because the longer the payment period, the more interest accumulates.
4. Down Payment – The larger your down payment, the lower your monthly payments will be.
5. Credit History – A good credit score can qualify you for a lower interest rate, reducing your monthly payment.

When it comes to car loan monthly payments, there are two things you definitely want to avoid:

• A high monthly payment that strains your finances and limits your ability to enjoy life.
• An excessively long loan term. Car salespeople might encourage you to extend your loan term to 72 months or even 96 months. While this can reduce your monthly payment and make it seem more affordable within your monthly budget, it’s not advisable. The car salespeople may tell you that with extended loan term you can “afford” a more expensive car and some cool addons. But opting for a longer payment term means paying a lot more in interest over time. Additionally, should you need to sell the car, you might find yourself owing more than its current value. So, no, thank you 🙂

Therefore, before heading to a car dealership, it’s essential to have a clear budget and a good understanding of what’s acceptable and what’s not.

Formulas to Determine How Much Car You Can Afford with Your Salary

Yes, there are several formulas or rules recommended by financial experts that can help you figure out how much car you can afford based on your salary. So, let’s review them before we dive into the car affordability calculator.

What is the maximum CAR LOAN AMOUNT can you afford?

Particularly, there are two formulas to help you determine the car loan amount you can afford—one is more liberal, and the other is more conservative:

35% Rule (Liberal)

Financial experts from Money Under 30 recommend:

As a rule of thumb, never spend more than 35% of your gross annual income on a car.

This rule suggests that your total car loan amount should not exceed 35% of your gross annual income. For example, if your annual income is $55,000, you can afford a car loan up to $19,250.

2-3 Months Rule (Conservative)

According to this rule, your total car loan amount shouldn’t exceed the equivalent of 2 or 3 months of your gross salary. So, if you earn $55,000 a year, which translates to a monthly salary of $4,583, you can afford a car loan amount of either $9,166 or $13,749.

What is the maximum MONTHLY PAYMENT you can afford?

There are also two formulas to help determine the monthly payment you can afford, with one being more liberal and the other more conservative:

The 10/20 Rule (Liberal)

Financial Experts from NerdWallet recommend:

Aim to spend less than 10% of your take-home pay on your car payment and less than 15% to 20% on car expenses overall.

This rule states that you can afford a car loan monthly payment that doesn’t exceed 10% of your monthly salary. (For simplicity we will calculate it based on Gross salary). And your total transportation costs should not exceed 20% of your gross monthly salary. For example, if you earn $5,000 a month, you can afford a monthly payment of $500, and your total car expenses should not exceed $1,000.

The 20/4/10 Rule (Conservative)

Finally, according to this rule, you should:
– make a 20% down payment,
– have a car loan term of no more than 4 years, and
– your total transportation expenses (including monthly payment, gas, insurance, maintenance, etc.) should not exceed 10% of your gross monthly salary.

However, these formulas may seem a bit complicated and confusing. And that’s why I’ve created an Excel file with an easy car affordability calculator. It includes all these formulas and allows for flexibility in your calculations, whether you prefer a more liberal or conservative approach. You’ll also be able to see the interest rate based on your credit score, which is very helpful, and estimate your monthly car expenses. Ultimately, you’ll see exactly:
– how much car you can afford,
– what your monthly payment would be, and
– the total interest you will pay.
This provides full visibility. The calculator is available for purchase on my ETSY account.

However, it’s important to remember that these rules and formulas are not one-size-fits-all solutions. They don’t account for your monthly spending or other loans and payments you may have.

That’s why the calculator I’ve created also allows you to input your monthly expenses. These rules and formulas serve as guidelines to show you the maximum you can afford, assuming you have the funds available. If you don’t have disposable income each month, it’s best not to use these formulas to decide how much car you can afford with your salary.

Just a small note. Dave Ramsey, whom I admire, suggests that the car you can afford is the one you can buy in cash. Without taking out any loans 🙂

Now, let’s explore my car affordability calculator.

How Much Car You Can Afford With Your Salary – A Simple Calculator

In the Excel file I have created, you will find 5 steps:

STEP 1. Calculating How Much Money You Have Available for Car Ownership

In this step, you can insert your gross monthly income and your current monthly expenses, including housing, food, utilities, taxes, etc. The calculator will show you how much money you have available every month for car ownership. Total car ownership includes a car loan monthly payment and future car expenses like gas, insurance, maintenance, etc.

STEP 2. Calculating a Monthly Payment You Can Afford

Here, you can estimate your future car expenses such as gas, insurance, maintenance, repairs, registration, and taxes. After filling in these estimates, the calculator will show you how much money will be left available for a car loan monthly payment. You will see two options automatically calculated for you:
– a Liberal approach (20% according to the 10/20 rule), and
– a more Conservative approach (10% according to the 20/4/10 rule).

STEP 3. Calculating a Maximum Car Loan Amount You Can Afford

This step will automatically calculate the maximum car loan amount you can afford:
– with a Liberal approach (35% rule), and
– with a more Conservative approach (2-3 months rule).
The only action required here is to insert ‘2’ or ‘3’ in the “conservative” table. The rest will be calculated automatically.

STEP 4. Choosing APR and Loan Term

This step allows you to select your average APR (annual percentage rate) based on your credit score. Note that the average APR will differ depending on whether you intend to finance a new car or a used car. After selecting your APR based on these two parameters (credit score and new/used car), the calculator will automatically insert your annual interest rate into the car affordability formula and calculate your monthly interest rate.

Also, in this step, you will see a recommendation for the car loan term – if you want to finance a new car, the maximum recommended loan term is 48 months, and for financing a used car, it is 36 months. Please note that the loan term length is not automatically inserted into the formula. The calculator allows you to insert it manually in step 5 and adjust the formula as needed.

STEP 5. Can You Afford That Car?

This step allows you to input the desired car value, the down payment (recommended 20% as per the 20/4/10 rule), and the loan term (recommended 48 months for a new car and 36 months for a used car). The file will automatically calculate if you can afford this car with all four formulas – according to the maximum Car Loan Amount you can afford (liberal/conservative) and the maximum Monthly Payment you can afford (liberal/conservative).

Amortized Car Loan Calculation

Additionally, there are two other tabs in the file called “New car 48 months” and “Used car 36 months”. They provide you with a detailed breakdown of your payments throughout the entire loan term. You will be able to see how much of each of your monthly payments goes towards the principal balance and towards the interest. Also, you will see the total interest paid. So, after going through all 5 steps in the first tab, then:

• If you are looking to finance a new car, please go to the tab “New car 48 months”, and
• If you are looking to finance a used car, please go to the tab “Used car 36 months”.

PLEASE NOTE: This file is not a commercial offer or financial advice. The real interest rates you get at the car dealership may differ from those in the file. The file is intended to provide visibility into your potential future car loan payments and car ownership expenses. So you can decide how much car you can afford with your salary.

BOTOM LINE:

Navigating the journey to car ownership is not just about picking the right set of wheels. It’s about making a financially sound decision that aligns with your lifestyle and budget. Armed with the knowledge of total car ownership costs, the impact of loan factors, and the strategic formulas shared in this guide, you’re now equipped to make a choice that won’t lead to financial distress or regret.

My comprehensive car affordability calculator is designed to demystify the often complex calculations, offering a personalized look at what you can truly afford based on your unique financial situation. Remember, the goal is not just to drive off the lot in a car that feels right. But to do so in a way that keeps your finances healthy and your future secure. So, before you step into a dealership, take a moment to consider not just the car that catches your eye, but the one that fits comfortably within your financial landscape. Because in the end, the best car for you is one that brings joy, not financial burden.

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