How to Buy a Car: How Much Should I Spend on a Car? Part I

So you’re thinking about buying a car. Maybe your current one has seen better days. Maybe you’re just ready for a change. Or maybe you don’t have one at all and are just plain tired of not being able to get around easily.

You’re at a place where you either want a car or maybe desperately need one. The very first thing you need to know is how much can you afford to pay for a car.

How Much Money Do I Make?

And the first thing you need to do to figure that out is calculate your gross monthly income. That is, your total income before taxes.

For some people, this is pretty easy. You could simply use the Income Calculator.

But this is really only good for people with one source of income, like a regular paycheck. If you get money from other sources, you have to add that in as well.

Some additional income sources could include alimony, child support, social security, disability, income from a second job, or income from your own side business. Any and all of those should be added to your pre-tax income from your primary job.

For example:

Job Salary: $3,000 per month ($36,000/yr.)

Child Support:   $300

Side Business:   $200

Total Income: $3,500 per month

See, not so difficult!

So How Much Can I Afford?

Okay, this part is a little trickier. There are several schools of thought about how much you can afford to spend on a car.

The really, really conservative financial types say you shouldn’t buy a car at all unless you can pay for it in cash up front. Yes, this will save you lots of money in interest but it’s just not financially feasible for most people.

Other folks recommend spending no more than 10% of your gross monthly income on a car. In the example above, that would mean $350 per month.

But wait! Most financial experts suggest including – at minimum – insurance costs, too. If your insurance runs $80 per month, that would leave you with $270 per month for an actual car payment.

The problem with this method is that it doesn’t really take into account your other bills. If you have no other debts or you just happen to live somewhere rent free, you can probably spend more. On the other hand, if you have school loans or credit cards that are taking a big chunk out of your pay every month, you might not be able to afford as much.

Consumer Reports has a more complicated calculation that takes these things into account. Essentially, they recommend spending no more than 36% of your gross monthly income on debt, to include rent or mortgage, credit card payments, school loans, and other loans.

With this method, first calculate 36% of your monthly income. In the example above, this would come to $1,260.

Then you add up your existing debts and subtract from the 36%. Let’s assume you have rent of $800 per month and a credit card balance that you pay $100 per month on. That’s $900, subtracted from $1,260 equals $360 per month for your car.

Subtract out the $80 per month for insurance and you can spend $280 per month on car payments.

Now you’re ready, right? Nope, not yet.

In fact, shopping for a car based only on what monthly payment you can afford is exactly the wrong thing to do.

Next week we’ll explain why. See you then!