How much car can I afford?

You’re ready to buy a car, but might be asking yourself, can I afford a car? Answering that question can ensure you don’t end up stretching your budget too thin with a car you can’t comfortably afford.

Before taking out any kind of car loan, understand what your personal borrowing power is so that you know what you’re eligible for and can steer clear of financing you can’t afford.

How much car can I afford?

One of the best ways to decide how much car you can afford is to use strategies like the 20/4/10 rule and the 10% to 15% rule. These strategies factor in important (and expensive) costs beyond the loan payment, like insurance, gas and maintenance so that your car budget is both realistic and affordable.

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What is the 20/4/10 rule?

The 20/4/10 rule suggests that you make a 20% down payment, get a loan term 4 years long or less and keep monthly car payments (including principal, interest and all operating costs) at or below 10% of your monthly pre-tax income.

The 20/4/10 rule is meant to be a guideline to help you calculate how much car you can afford – it’s not a strict rule. If you can only afford to put 15% down or need to extend your car loan term to 5 or 6 years, that’s okay.

20% down payment

The 20/4/10 rule suggests you use a down payment of around 20% when buying a car to offset the loss from depreciation as soon as you drive off the lot. For example, you would need a $4,000 down payment for a car costing $20,000.

Start saving for your down payment as soon as possible. Making a down payment will reduce the risk of incurring negative equity – which is when you owe more against the car than what it’s worth.

4 year loan term or less

Car loan terms usually range between 2 and 7 years. However, the 20/4/10 rule states that you should aim for a 4-year term or less. The longer your term is, the more interest you’ll pay. By shortening the term, you’ll reduce the costs of financing.

In addition, longer loan terms can have a negative impact on your car insurance costs. You can compare car loan terms and interest rates from a range of lenders in the table below.

10% of your monthly income on all car expenses

The last component of the 20/4/10 rule is to keep all costs of car ownership to 10% or less of your pre-tax monthly income. If you spend too much on your car, you may struggle to meet your other financial commitments.

Remember that operating costs include more than just the car loan payment – consider gas, insurance, maintenance, licence and registration, parking, and so on.

The 10% to 15% rule for how much to spend based on salary

The 10% to 15% rule gives you a general guideline to estimate how much car you can afford based on your salary. The rule states that the total operating cost of a car should fall between 10% and 15% of your annual income. Check out the below table to determine how much car you can afford based on salary.

This rule helps you budget for a car based on salary, while ensuring you’ll still have income available for other living costs, savings, emergency funds and so on after covering your vehicle expenses.

Remember that the 10-15% rule is merely a guideline. If you spend closer to 20% of your salary, that’s okay too. Everyone’s budget is unique which means some can afford to spend more on a car.

What car can I afford with my salary?

Using the 10-15% rule to understand how much car you can afford based on your salary is a good way to help narrow down your vehicle options. To help give you an idea of what car you may be able to afford with your salary, here are some potential options.

Keep in mind that the 10-15% rule is designed to take into account all operating costs including insurance and gas, which will vary a lot based on the type of car, where you live and how often you drive. So these example vehicles may not fit all budgets, but instead can be used simply as a starting point for you search.

What car can I afford with a $40k salary?

What car can I afford with a $70k salary?

What car can I afford with a $100k salary?

Gas prices for popular makes and models in Canada

With the cost of gas on the rise, it’s important to make sure you factor in realistic gas prices when making your budget to decide how much car you can afford. To help you out, we’ve compiled a list of example gas prices in Canada for popular used car models assuming you’re filling up a full tank of gas from empty.

Calculate how much car you can afford in 3 steps

There are 3 main steps to determining how much to spend on a car.

Step 1: Determine how much to spend on a car based on income and savings

In general, there are 3 main costs associated with buying a car: the down payment, the car loan payment including principal and interest, and the ongoing operating costs.

It’s easy to find a car loan with no down payment, but most lenders prefer between 10% and 20% upfront when you apply for car financing. Having a large down payment lowers the amount you need to borrow to pay for the car, making it easier to qualify for a loan.

Look into your savings to figure out how much funds you have available to put down without disrupting your monthly spending habits. Don’t have any savings? You might want to hold off on the car loan until you do.

When determining how much you should spend on a car, there are a couple of ways to go about it:

• Review your budget and determine how much you can reasonably afford to spend on a car monthly. Also consider your savings and how much you’re willing to spend upfront on a down payment.
• Use the 20/4/10 rule: 20% on a down payment, a loan term no longer than 4 years, and 10% of your pre-tax income on car loan payments and operating costs.
• Use the 10% to 15% rule: 10-15% of your pre-tax annual income is a benchmark for car loan payments and operating expenses.

Step 2: Shop around for cars

At this point, you should have a figure in mind for the down payment and monthly operating costs, including car payments and other car ownership expenses. Now you can begin shopping around for cars that are within your budget. Make sure to research the car price, insurance, gas, repairs and maintenance, and other costs of ownership. Fortunately, most of this information can be found through a simple Google search. Check out our guide to the best car-buying apps and sites in Canada to start your search, which includes:

• AutoTRADER
• Car Loans Canada
• Kijiji
• Facebook Marketplace
• Unhaggle

Best cars under $25,000

Step 3: Put your budget to the test

Once you have a few cars in mind, it’s time to put your budget to the test. Do the cars you want actually work with your budget? After your down payment, is the monthly car payment and operating costs still within the amount you allocated? To answer these questions, check out the car affordability calculator for Canada below.

If you find that the cars you want don’t fit within your budget, you have a few options. Either explore cheaper cars or revisit your budget. If you still can’t find a way to fit a car into your budget, it may not be the right time for you to make a car purchase.

• How to use this car loan monthly payment calculator

  1. Enter the amount you want to borrow to buy a new car under “Loan amount”. If you’re making a down payment, be sure to subtract the down payment from the total loan amount.
  2. Write the amount of time you have to pay off your car loan under “Loan terms” (in years).
     If your loan term is in months, divide it by 12 first.
  3. Enter the interest rate you expect to pay on a car loan under Interest rate. If your car loan comes with fees, enter the annual percentage rate (APR) instead.
  4. Click “Calculate”.

  In addition to your monthly payment, this calculator shows how much you’d pay on your loan’s principal amount and how much you’d pay overall in interest. The principal amount is the amount that you borrowed and should be equal to your loan amount. Total interest is the amount you would pay on top of the principle, the cost of having your loan.

How do lenders determine my borrowing power?

Borrowing power is the amount of money that you can borrow at a specific point in time, based on your financial position. Lenders may use the criteria below to determine the final amount you’re able to borrow:

• Your credit score. This is usually the most critical component that influences how much you may be able to borrow. Lenders use your credit score, and credit history, to predict the potential risk of a borrower.
• Annual income. Lenders consider your income when determining your ability to repay a loan. If a lender doesn’t feel that your income will allow you to repay a larger loan properly, it may only approve you for a smaller amount.
• Multiple incomes. The more income you have, the more borrowing power you have.
  Living expenses. Lenders want to be sure that your new car payment will fit into your budget along with housing costs, utility bills, credit card bills, student loans and other monthly bills.
• Your savings. How much you have in your savings account could be used as a buffer in the event you’re unable to repay a car loan with your normal income. If you have more cash savings, a lender may approve you for a larger amount.
• People who are financially dependent on you. Having dependents can add to your monthly expenses, which can impact your borrowing power.

Debt-to-income ratio and borrowing power

Another important factor that is rolled into how much you can borrow is your debt-to-income ratio. A good rule of thumb is that the debt you pay each month should account for no more than 36% of your monthly income; anything much higher may be seen as a red flag.

Note: If your calculation includes only minimum payments on your credit card(s), your debt-to-income ratio is actually higher than you figured. This is because minimum payments don’t show that you’re eliminating debt, just that you’re maintaining it. When looking at your finances, lenders are specifically looking to see how good you are at getting rid of debt. After all, they want you to pay back your car loan, not struggle to make your payments.

How can I increase my borrowing power?

There are a few different ways to convince lenders that you’re capable of taking on a bigger loan, however, it may take some time and effort. A few strategies you can use to get a bigger loan in the future are:

• Spend less. Drawing up a budget and sticking with it can free up some cash flow and help you create less debt. And once your start spending less, you can take those savings and knock down whatever debt you’ve accumulated in the past.
• Improve your credit score. Paying bills on time, decreasing your debt-to-income ratio, using your credit card responsibly and correcting mistakes on your credit report can nudge your score in the right direction.
• Eliminate your debt. Cutting your debt minimizes your credit utilization ratio, showing lenders that you’re not desperate for a line of credit.
• Ask for a pay raise. Doing a great job at work and think you deserve a raise? Draw up a case as to why you deserve a pay increase. This extra bump will decrease your debt-to-income ratio and make you appear as a more attractive borrower.
• Compare. Every lender may look at your ability to borrow differently. This is why it’s extremely important to get a few quotes and do your research before moving forward with the first loan offer.
• Get a cosigner. A cosigner promises to take care of the loan if you default, increasing your borrowing power. Only ask someone to be a cosigner if you’re sure you’ll have no problem making the payments on your loan.

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How do I avoid overspending on a car loan?

1. Compare rates before visiting the dealership

One of the most common pieces of advice is to get preapproved for a car loan with 2 or 3 lenders before you visit a dealership. Not only will this allow you to see what types of rates you can expect, but you’ll also have another tool in your arsenal when it comes time to negotiate. Dealerships are notorious for marking up interest rates to earn a larger profit, so comparing rates will help you get the best deal.

2. Opt for a shorter loan term

The longer your loan term, the more you’ll pay in interest. While opting for a lengthy term will lower your monthly repayments, it can cause you to go upside down on your car loan. This means you owe your lender more than your car is actually worth.

Although there are 72- and 84-month terms available, try to go for a term no longer than 60 months, or ideally no longer than 48 months according to the 20/4/10 rule. And if you’re buying a used car, try to keep your term even shorter: a 36- or 48-month term can save you thousands of dollars over the life of your loan.

3. Focus on the overall price of the car

With 84-month terms available on new cars, keep a strict rule about how much you’re willing to pay overall for the vehicle. Salespeople try to inflate the price of the car to meet the amount you’re willing to pay monthly by tacking on add-ons you don’t need. While your monthly payment amount is important, be sure to keep an eye on your total cost too.

4. Be on the lookout for fees

Make sure you understand any fees you might be charged on top of interest. Often, you’ll be charged an origination fee (often included in the APR) when you first take out a loan. Ask whether you’ll face a prepayment penalty for making extra repayments or for paying off your car loan early.

Most lenders also charge a late fee, although there might be a short grace period. In addition to regular fees for borrowing, you’ll also be responsible for sales tax, registration costs and licensing fees. These vary depending on your province/territory, the car you buy and the dealership you choose.

When working with both the lender and dealership, ask for a breakdown of fees. You could negotiate these if you found a more competitive offer elsewhere. Check out our guide on the true cost of buying a car to learn more.

5. Review your terms before signing

You’re bound to any loan contract you sign. Before committing to anything, read through the contact carefully, making note of the interest rate, loan term, fees and monthly payment. Be on the lookout for any language that might be signs of a scam, like extra fees you don’t remember discussing. If your lender or salesperson can’t explain anything that doesn’t look right, you may want to hold off on your purchase until you can find a more reputable provider.

Bottom line

Remember to take into account all fees and taxes including the cost of the vehicle when determining how much car you can afford. Using strategies like the 20/4/10 rule or the 10-15% rule can help you calculate exactly how much you can afford based on your salary. Now that you know what to expect from lenders and what kind of borrowing power you have, you’re ready to compare car loans.

Frequently asked questions about car affordability

• What are the typical fees I should expect when buying a car?

  While the exact fees you'll end up paying will vary based on your area and the car you buy, taking these into consideration can be a good starting point:

  • Sales tax. Typically, taxes may cost 5% to 15% depending on your province.
  • Registration fees. You can estimate these by visiting your provincial service centre.
  • Processing fees. Yours will vary by dealership and province, but commonly it ranges from $100 to $400.

• I have bad credit and want to buy a used car. Are there loans available to me?

  Yes, there are many bad credit car loan options in Canada. While you may have a harder time qualifying with banks if you have bad credit, there are many reputable online lenders who will be willing to finance your car purchase. You can check out our guide to buying a used car to explore your used car loan options specifically.

• Do I need to be employed, and for how long, before applying for a car loan?

  Depending of the lender, you may need to be employed for anywhere from 3 months to 2 years before applying for a car loan. However, most lenders will be satisfied to see that you've steadily held down a job for at least 6 months. You may be able to get a car loan without a job as long as you can show some sort of savings, provide proof of any non-traditional income you may be getting (government payments, annuities, returns on investments) and possibly make a large down payment on your car.

• How much car can I afford if I already have a car loan?

  If you already have a car loan, adjust the amount you borrow to account for the final payoff amount — not just the remaining balance. You can add this to the total amount you request for your car loan, but be sure to keep your budget in mind when you do this. If it pushes you beyond that 10% to 15% threshold, you may want to hold off on buying for now and wait until you've paid off a little bit more. In this case, you may want to consider refinancing your car loan instead.

• Is it cheaper to lease a car instead of buying one?

  It depends on whether you're focused on the long-term or short-term costs. Leases generally have lower monthly payments than car loans, but any equity your car maintains is lost when you return it to the leasing company. This means they're good for short-term budgets, but are typically more expensive in the long run since you'll never get to the point where you own the car and no longer have to make payments.

  You can learn more in our guide to buying a car versus leasing.