How much car can I afford? How to calculate car affordability

How much car you can afford depends on factors like your monthly income, your credit score and your down payment. Experts typically recommend spending no more than 20 percent of take-home pay on a car. That should include the cost of car payments, fuel, insurance and more.

1. Decide between leasing and buying

Whether you’re leasing or buying a car makes a difference in what you can afford.

Leasing is a great option for drivers who want a lower monthly payment and the ability to drive the newest models. Your payments cover the vehicle’s depreciation rather than its total value. However, you still need to put money down — and you’ll be paying to maintain a car you ultimately will not own.

Buying places you fully in the driver’s seat with no mileage limits or additional charges for wear and tear. It costs more to buy a car than to lease it, and you should ensure depreciation won’t leave you upside-down on a loan. But you will own the car and be able to sell it if needed.

Use a leasing versus buying calculator to calculate your potential savings. What is affordable comes down to how you plan to use your vehicle, so read up on the full benefits and drawbacks of each before you commit.

2. Consider your salary

Your salary is one of the primary factors in determining which auto loan is best for you.

• Edmunds recommends that a new car payment be no more than 15 percent of your monthly take-home pay.
• A used car payment should be no more than 10 percent, but that number can vary depending on if it’s a certified pre-owned car or a newer model.
• When insurance, fuel and other regular monthly expenses are included, the cost should not exceed 20 percent of your monthly take-home pay.

Your income also matters if you are trying to get approved for a loan. Lenders will look at your debt-to-income ratio, or DTI. This measure compares your monthly bills to your gross monthly income. Most car dealers like to see a DTI no higher than 45 or 50 percent before approving a loan, according to The Car Connection.

Even if you have the cash available to pay for your car outright, you should still consider your purchase in the full context of your annual salary and expenses. Specifically, weigh buying in cash — and possibly eating into or wiping out your emergency fund — versus making affordable payments over time.

You may want to avoid an auto loan, especially if you stand to spend more than the recommended amount of your income each month toward a loan. For some buyers, financing a vehicle may make sense when balanced as a part of their larger financial picture.

3. Estimate your monthly car payments

The interest rate you receive on an auto loan plays a big part in calculating your monthly payment amount. A higher credit score will score you a lower interest rate, which will ultimately lower your monthly payment and your total overall loan cost.

You can use a car loan calculator to determine how different interest rates will affect your monthly payment. To get started, follow these quick tips:

• Pull a copy of your credit report and learn your credit score.
• Get prequalified with at least three lenders to determine the average interest rate you could be offered.
• Plug your interest rate, desired repayment term length and car price into the calculator.

The loan term is the second factor you should consider. A shorter loan term means bigger payments but less interest paid overall. So, while a long loan term can be tempting, it may be better to go with a less expensive vehicle to keep payments affordable.

4. Determine your out-the-door price

The payments on your vehicle loan will include more than just the cost of the vehicle alone. Be mindful of the out the door (OTD) price, which will factor in not only the cost of your vehicle but also taxes, fees and any add-ons you purchase.

With research, you can learn what to expect in state sales taxes and title and vehicle registration fees.

While some dealer fees are required by law or company policy, others may be on the table for negotiation or removal. Understanding what is and isn’t open for discussion can save time and frustration at the negotiation table.

With an affordable OTD cost in mind, you can aim for a certain sticker price while shopping for a vehicle. Understand that your OTD cost will add 10-15% to your car’s price, depending on your locale.

5. Factor in additional vehicle costs

Two of the largest additional costs that come with car ownership are fuel and insurance costs. You can use fueleconomy.gov to search for mileage estimates for your car of choice. Selecting a car with good gas mileage will save you money each month and could help you maximize any employer mileage reimbursements.

Insurance costs also vary by vehicle and individual. Two cars that look similar to you might be vastly different to your insurance company. A car insurance calculator is a great place to start understanding your potential insurance costs and what factors the insurance company considers when developing a price quote. Typically, companies will evaluate:

• Your driving record.
• How much you use your car.
• Your location.
• Your age.
• Your gender.
• Your credit.
• The type and amount of coverage you selected.
• The discounts you qualify for.

Depending on the state you live in, there may be restrictions on the personal information insurance companies can use when pricing your auto insurance.

Beyond the monthly payment, you should consider if you can afford to maintain the vehicle. Get a few car insurance quotes and use a cost-to-own tool to see estimates of what you might pay.

Edmunds and Kelley Blue Book have cost-to-own tools that account for expected fuel costs, maintenance, repairs, state fees and average depreciation.

Bottom line

Being realistic with your budget will help you avoid pinching pennies after bringing your new ride home. Before settling on a car, consider all potential costs, not just the monthly payment. Aim to find a car that costs no more than 20 percent of your take-home pay.

The goal is to find a car that meets your expectations and leaves you with money to cover unforeseen costs or income changes.