Fitting a new car into your budget can feel like navigating a financial maze. Experts often disagree, adding to the confusion. Some suggest your total car expenses—including gas, insurance, and payments—shouldn’t exceed 20% of your pre-tax monthly income. Others propose a car price roughly half your annual take-home pay. And then there are the ultra-frugal gurus who advise limiting your vehicle purchase to just 10%-15% of your annual income. With terms like pre-tax, post-tax, and annual income swirling around, it’s no wonder you’re asking: “How much car can I actually afford?”.
While there’s no magic formula, a practical guideline is to aim for a new car payment that’s no more than 15% of your monthly take-home pay. If you’re considering leasing or buying used, even more conservative, around 10%, is wise. This 10%-15% rule isn’t arbitrary. The car payment is just the tip of the iceberg. Don’t forget about ongoing expenses like fuel and insurance, costs that are frequently underestimated. We recommend budgeting an additional 7% of your take-home pay for these, bringing your total car expenses to a more manageable 20% of your monthly take-home income.
This 10%-15% guideline may not be a perfect fit for everyone’s situation, but it serves as an excellent starting point. It helps you establish a target price range, increasing the likelihood you can comfortably manage your car expenses without financial strain each month. Let’s break down how to calculate a more personalized car affordability figure.
1. Calculate Your Car Budget
Take a moment to assess your monthly spending habits. Start with your monthly take-home pay—that’s your income after taxes and deductions. Then, systematically subtract your essential monthly expenses: rent or mortgage payments, utility bills, groceries, childcare costs, savings contributions, and entertainment spending. What remains after these deductions is a clearer picture of your disposable income, and thus, how much car you can realistically afford.
If you’re unsure what types of vehicles fit within your budget after determining your ideal monthly payment, online tools like the Edmunds affordability calculator can be helpful. These calculators allow you to input your target monthly payment and explore vehicles that fall within that price range. Remember that the prices displayed are starting points and can fluctuate based on factors like trim level, optional features, local sales tax, and registration fees.
Feeling like your affordability calculation is lower than you hoped? You’re not alone. Vehicle prices have increased significantly over the years, often outpacing wage growth. Regardless, the amount you’ve calculated now represents your realistic automotive budget. It’s crucial to remember this budget encompasses more than just the monthly car payment. Next, let’s consider fuel and insurance costs.
Alt text: Man thoughtfully using a calculator to determine his car affordability budget.
2. Factor in Fuel and Insurance Costs
Before you finalize any car purchase or lease, it’s essential to estimate your ongoing fuel and insurance expenses. These costs can vary significantly based on several factors, including your geographic location, driving history, and the specific vehicle you choose. While it requires a bit of upfront research, accurately estimating these expenses is a crucial step you shouldn’t skip. Understanding these variable costs can be the deciding factor when comparing different vehicles. Some models might be more fuel-efficient, leading to lower gas costs, while others might fall into higher insurance premium categories.
A valuable resource for estimating fuel costs is the EPA’s Fueleconomy.gov website. This site provides detailed fuel economy ratings and annual fuel cost estimates for both new and used vehicles.
For accurate insurance quotes, contact your current insurance agent or explore online auto insurance websites. Most providers offer online quote tools where you can input vehicle information and receive an estimated premium. Ideally, when you add your estimated fuel and insurance costs to your potential car payment, the total should remain at or below that 20% of your monthly take-home pay target. If it exceeds this, it’s time to re-evaluate your vehicle choice or budget.
3. Consider Your Car Buying Habits
Beyond the numerical formulas for car affordability, understanding your own car-buying tendencies, both positive and negative, can provide valuable insights into the best approach 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, enjoying payment-free driving for a while? If so, purchasing a new car might be a suitable option for you. Your history demonstrates responsible financial behavior when it comes to vehicles.
On the other hand, do you tend to get restless with a car after just a few years, constantly wanting to upgrade to the latest model? If this sounds like you, leasing might be a more financially sensible strategy. Committing to a six-year auto loan when you know you’ll likely want to trade in the vehicle in the fourth or fifth year can lead to financial pitfalls. You could end up owing more on the loan than the car is actually worth, creating negative equity that gets rolled into your next loan, perpetuating a cycle of debt. Leasing allows you to enjoy a new car with potentially lower monthly payments and the flexibility to switch vehicles more frequently. Leasing can also sometimes allow you to drive a more luxurious vehicle for a similar monthly cost compared to purchasing.
Finally, if your primary goal is to make the most financially sound car decision possible, purchasing a lightly used car, paying it off aggressively, and keeping it for the long haul is often the most economical path. The first owner absorbs the steepest depreciation in value, and you benefit from a vehicle that’s still relatively new and less likely to require immediate major repairs.
Alt text: Two people in a car dealership discussing different car buying options and affordability.
An Example: John’s Car Buying Scenario
To make these budgeting concepts more concrete, let’s consider a hypothetical example using real-world financial data. According to the U.S. Bureau of Labor and 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 roughly $47,216.
Assuming a 20% estimate for income taxes, this individual, whom we’ll call John, would have a monthly take-home income of about $3,148. Applying our 15% rule for a car payment, John 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. Let’s imagine John decides to purchase a new Honda Pilot at this average price. Assuming solid credit and average deal terms, including an 11% down payment (approximately $4,075) and the most common loan term of 72 months, John’s monthly car payment would be around $542.
Immediately, John is exceeding his recommended budget based on the 15% rule, and this doesn’t even include fuel and insurance costs yet.
Estimating fuel costs at $120 per month and auto insurance at $140 per month, John’s total monthly automotive expenses jump to $802, or about 25% of his monthly take-home pay.
While some individuals might be comfortable allocating a quarter of their take-home pay to car ownership, in John’s situation, this level of expense could create significant financial strain. Consider those earning less than John, individuals with less-than-perfect credit, or those managing existing debt – new car ownership at this price point becomes a significant challenge. At this point, John’s options are to consider a less expensive vehicle, explore leasing, or consider a used car instead.
The Used Car Option
What would John’s financial picture look like if he opted for a used car? The initial purchase price would be lower than a comparable new vehicle, and often, the credit requirements for a used car loan can be less stringent. Again, using average figures, let’s assume John chooses a used vehicle with an average financed amount of $22,623. With a down payment of just over 10% (around $2,660), the monthly payment would be approximately $416, with a typical loan term of 68 months. Used car loans generally carry higher interest rates than new car loans, often about 3 percentage points higher, which is typical in the lending market.
Fuel costs would likely remain similar to a new car. Insurance costs might be slightly lower due to the vehicle’s depreciated value. However, any insurance savings could be offset by potential increased maintenance costs associated with an older vehicle. For simplicity, let’s assume the combined fuel and insurance costs remain around 8% of John’s take-home pay, similar to the new car scenario.
By choosing a used vehicle, John’s total monthly car expenses would be approximately $676, or about 21% of his monthly take-home pay. On the surface, this appears to be a more cost-effective option due to the smaller loan amount.
However, it’s important to consider that John would be committed to loan payments for five and a half years. By the time the loan is paid off, the used car would be 8 or 9 years old. How much longer would John realistically want to drive it before considering another vehicle purchase? This is a crucial factor to weigh when choosing a long loan term. The goal of financing is to eventually become free of car payments. If John plans to purchase another SUV as soon as the used car loan is paid off, leasing might be a more strategic option. Let’s examine leasing.
The Lease Option
In 2019, the average three-year car lease had a monthly payment of $465 and an average down payment of $2,646. It’s important to note that these average lease figures are often skewed higher because they include a significant number of luxury vehicle leases (brands like BMW, Mercedes-Benz, etc.). Since John isn’t looking for a luxury car, he should be able to find a lease deal on a midsize SUV for roughly $400 per month with a down payment closer to $1,800. A key consideration with leasing is mileage limits. Most advertised lease specials come with a standard mileage limit of around 12,000 miles per year. Exceeding this limit incurs extra charges, potentially adding around $25 per month for every additional increment of miles.
John’s estimated lease payment of $400 per month would be a more manageable 12.7% of his take-home pay. Adding the estimated 7% of take-home pay for fuel and insurance, John’s total monthly car expenses under a lease would be approximately $660, or about 21% of his monthly income. This is slightly above our recommended 20% target for total automotive expenses.
In this scenario, John would have a lower monthly expense with leasing compared to purchasing. He would also have more cash available upfront due to the smaller down payment. However, the trade-offs are the mileage limitations and the need to repeat the car acquisition process in three years when the lease term ends.
What’s the Best Car Affordability Approach?
Each of these car affordability approaches—buying new, buying used, or leasing—has valid arguments in its favor. The most suitable option ultimately depends on your individual financial situation, driving habits, and long-term financial goals. It’s crucial to be honest about your car-buying history and tendencies. If you choose to commit to a long-term auto loan, ensure you plan to drive the vehicle for several years beyond the loan payoff period to truly maximize the financial benefit.
Ultimately, the best car-buying decision aligns with your overall budget and financial responsibilities. Avoid shopping for a vehicle at the absolute upper limit of your calculated budget. And if purchasing a car feels like a financial stretch right now, consider postponing the purchase, saving more diligently, and revisiting your car shopping plans when you are in a more comfortable financial position. The most important takeaway is to thoroughly understand your budget and always remember that the monthly car payment is only one component of the total cost of car ownership.
