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If you're planning to buy a car, it's essential to know what you can afford before you start shopping around. To determine how much car you can afford, it's important to know your budget, the costs associated with buying a car, how much you might pay in interest on a car loan and more.
Here's what you should consider as you get ready to buy your next car.
What Car Payment Can You Afford?
Generally, financial experts recommend keeping your monthly auto payment at or below 10% of your take-home pay. That's a good rule of thumb to get an idea of what to aim for, but it's crucial that you take a look at your own budget to get the right number.
If you already have a car payment, simply replacing it with an equal or lower monthly payment may be enough. But if you don't or you're looking at a pricier vehicle, you'll want to look at your income and expenses to determine what is the right car payment amount for your budget.
If your take-home pay or your expenses fluctuate from month to month, consider looking back on the last three to six months to see how much cash you have available to put toward a car payment.
Also, consider your other debts. If a significant portion of your monthly income goes toward debt, adding a car loan to the mix could make it challenging to get approved for credit in the future. That's especially the case if you're hoping to buy a house. Knowing your debt-to-income ratio and how it affects you can help you determine how much you can afford.
It's also important to look at the loan amount instead of focusing solely on the car payment, because the longer you're making payments, the more you'll pay in interest.
Finally, keep in mind that you can reduce your monthly payment by making a down payment on the loan. The more money you put down, the less you need to borrow, giving you a more affordable monthly payment.
What Car Loan Can You Afford?
The terms of your car loan will influence how affordable it is for you. One factor that can change a loan's cost is the repayment term. Depending on the lender, typical loan terms range from 36 to 84 months.
As previously mentioned, choosing a longer repayment term may sound like a money saver because it reduces your monthly payment. But over time, you could end up paying a lot more in interest.
For example, let's say you qualify for a $30,000 loan at 5%. If you choose a 60-month term and make no down payment, your monthly payment will be $566, and you'll pay $3,968 in interest over five years.
If you opt for an 84-month period instead, it'll drop your monthly payment to $424, but you'll end up paying $5,617 in interest over the seven-year term—that's $1,649 more that you could spend on things that are more important to you.
Another significant factor in the cost of your loan is its annual percentage rate (APR). The APR determines how much interest you pay on top of the principal amount of the loan. If you have excellent credit, you can generally expect to pay less in interest. If your credit needs some work, however, you could end up with a double-digit APR and thousands more in interest charges.
As such, it's a good idea to check your credit score before you decide to buy a car. If you find that it's not where you want it to be, and you don't need to buy a car right now, consider taking some time to improve your credit before taking the next steps.
How Your Credit Score Affects Your Car Loan Affordability
To give you a better idea of how much you could save by building credit before you buy, here are some examples of average loan rates, term lengths and loan amounts on a new car for different credit score ranges based on Experian data as of the fourth quarter of 2018.
| Score Range | Average Loan Rate | Average Term Length (in months) | Average Loan Amount | Total Interest Paid |
|---|---|---|---|---|
| 300-500 | 14.9% | 72 | $26,400 | $13,700 |
| 501-600 | 12.2% | 73 | $29,400 | $12,400 |
| 601-660 | 7.9% | 73 | $33,100 | $8,700 |
| 661-780 | 5.0% | 70 | $33,500 | $5,200 |
| 781-850 | 4.2% | 63 | $31,700 | $3,700 |
As the table shows, you could potentially save thousands of dollars by increasing your credit score from one range to the next. Even improving your score from the mid-600s to 700-plus could garner you an interest rate 3 percentage points lower on a car loan—which could help you save over $3,000 in total interest.
Of course, building credit can take time, especially if you have some negative items on your credit reports that are dragging down your scores. Here are a few steps you can take to get on the right track:
- Check your credit reports: Your credit scores are based on information found in your credit reports. By checking your credit report with Experian and the other credit bureaus, you can pinpoint the areas that need to be addressed. Also, check for potentially erroneous or fraudulent information that could be hurting your credit. If you find something you believe shouldn't be there, you can file a dispute with the credit reporting agencies.
- Get caught up on payments: If you have any credit accounts that you're behind on, get current on payments as quickly as possible and make on-time payments going forward.
- Pay down your credit card balances: If you have high credit card balances, paying them off can reduce your credit utilization rate and help improve your credit score.
Depending on the factors that are influencing your credit scores, taking these steps can help improve your credit scores and help you establish a positive credit history over time.
How to Calculate Total Costs
When you start shopping for your next car, it's important to look at more than just the sticker price. If you live in a state that charges sales tax, for instance, expect that to add to the total cost of purchasing the vehicle.
Also, consider documentation fees, title and registration fees, and other expenses the dealer tacks on to the contract amount. If you choose to add a warranty or maintenance contract, that's also going to affect whether you can afford the car.
You don't have to pay these costs out of pocket—in general, dealers will roll them into the car loan along with the sales price of the car. But they will increase your monthly payment.
In addition to necessary taxes and fees associated with a car purchase, you'll also need to think about the cost of car insurance, annual car registration, ongoing maintenance and repairs, fuel and other related expenses that go along with owning a car.
How to Save When Buying a Car
Regardless of your budget, here are some tips on how to save money when you're buying your next vehicle.
Buy Used
The average monthly loan payment for a used car is $161 cheaper than the average monthly payment for a new car, according to data from Experian Automotive. This savings adds up over the course of your loan to mean purchasing a used car instead of a new one could save you thousands of dollars.
Cars also depreciate over time, so the older the vehicle is, the less you'll pay. Just keep in mind that you'll want to balance the cost of the car and its reliability and safety. If you're not careful, you could save money on the purchase but end up spending thousands of dollars on repairs.
Buying a certified pre-owned vehicle could be a good alternative if you're worried about the condition of a used car. These late-model cars get a thorough inspection and reconditioning from the dealer, who makes any needed repairs and adds a limited warranty. You get a near-new car but pay less.
Shop Around
Start your car-shopping experience online by checking out multiple dealers in the area. If you already know what model you're looking for, run a search for it and compare prices.
If you're not sure what you want, this process can give you an idea of what prices to expect for different makes and models, and which may be the best fit for your budget.
Also, make sure to look up the value of the car on Kelley Blue Book or NADA Guides to get an idea of what the vehicle is actually worth. This may give you a bargaining chip with a dealer even if they're charging less than others in the area.
Don't Trade-In
Car dealers will offer to buy your existing vehicle and apply its value as a trade-in to your vehicle purchase, similar to a cash down payment. This approach is convenient, but you'll usually get more money if you sell the car on your own and use the cash as a down payment on the new car.
Not having another car to use in the meantime can make the process more challenging. But if you can, selling your car to a private party could make your new car more affordable.
Negotiate With the Dealer
The sticker price on a car is rarely non-negotiable. If you know how much the same make and model is going for with other dealerships and how much it's actually worth, you may be able to negotiate a deal with the salesperson.
What's more, if you visit the dealership at the end of the month, quarter or year, they may be more willing to talk if they have sales quotas to fill.
In addition to the sales price, you may be able to negotiate on fees and add-ons, such as a warranty, maintenance contract and more. In a worst-case scenario, the dealer can say no. But if it works out, you could save hundreds or even thousands of dollars.
Focus on Your Credit for Long-Term Results
If you're buying a car now, there are plenty of things you can do to save money. In the long run, though, the best thing you can do to save on credit is to improve your credit scores. Along with making payments on time and limiting your debt, consider using Experian Boost®ø, which may be able to improve your FICO® Score☉ by including your on-time phone and utility payments.
Building credit can take time, but your efforts can save you a lot of money long after you're done paying off your current car loan.