May 26

What Percentage of My Monthly Income Should I Spend On A Car Payment?


What Percentage of My Monthly Income Should I Spend On A Car Payment?

The short answer is none. The best way to pay for a car is with cash. Now that we have that out of the way, the 2nd best way is to finance as little as possible.

I get asked this question all the time and the answer will vary based on the amount of income you have.
For example, if you make $200,000 annually you should NOT spend 10% of your income monthly. You might however spend 10% of your income on a car payment if you bring home $2,000/month.

So, how do you know what to do? Here are a couple of “rules of thumb” that may help. Ultimately, it will come down to common sense.

  1. Keep the Term Short
    Finance the car for no more than 36 – 48 months. If you cannot pay it off in 36 – 48 months it could cause problems. Cars depreciate or go down in value and you could end up “upside down” or owing more than the car is worth. That can create its own set of problems. Particularly if you get in an accident, total the thing, and have to pay out of pocket to pay off your loan. Yikes!
  2. Budget Wisely
    Realize that to budget for what your car will truly cost you you should double your car payment amount. WHAT? That’s right. Match the car payment amount in order to budget for what you will average monthly for gas and maintenance like oil changes, tire rotation, and things like that. For example: If your car payment = $250 then your monthly gas will probably = $200. Now also add $50/month for maintenance for the car. You will not change the oil or rotate the tires monthly, but when something comes up (and it will) you will be prepared for it.
  3. Percentages Can Be Misleading
    If your income is $3000 – $5000 monthly, 10% – 5% respectively is probably a good mark to shoot for.
    For example:
    (1.) you bring home $3,000 use 10%
    (2.) you bring home $5,000 use 5%.
    It may sound strange, but think about it. If you bring home more you should save more for a down payment and thus finance less leaving you with a lower payment. If that is too much for you, just use 5% and some COMMON SENSE and move on.
  4. Use An Online Financial Calculator
    Figure out what your payment would be by using an Online Payment Calculator and plugging in the numbers for the car you are going to buy. You can change the one I’ve linked to, to let you plug in the payment and calculate for the amount financed. That will let you know how much you can shop for. Make sure to change the Payment Option to “fixed loan term”.
    $11,629 — Price including tax, tag, title.
    -$3,000 — Down Payment
    $8,629 — Amount Financed
    2.75% — Rate
    36 — Months
    $250.00 — Payment
  5. Pay Yourself First, Automatically.
    Once you have calculated that payment amount, start making monthly payments to your savings account long before you buy your car. Target 10 months if you can. Set this up as an Auto Transfer from checking or a direct deposit. It’s a fact. Making saving automatic not only helps you get to your goal, but also most banks will give you a rate discount to Auto-Draft your loan payments from a checking account. This “automatic savings payment” will get you used to the auto-drafting of payments too.

    While you are at it, load the “maintenance” amount you have to budget in there too. I would say put the gas portion in savings, but you will probably be using that to buy gas with for your current auto.After 10 months of saving a $250 payment plus $50 for monthly maintenance budget you will have accomplished 2 things.
    One, you will have a real feel for what that payment is going to cost you.
    Two, you will have $3,000 to put down on the vehicle. You will also have had time to think through the right car for you and shop around for the best financing.

Of course you know where I think the best financing is. If you get tired of using the online calculators or just want a real person to do the work besides you, call me. That’s what good Bankers are for.

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