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How much car can I afford?
Use these strategies to calculate how much you can afford to spend on a car based on your salary and monthly budget.
You’re ready to buy a car and even have your eye on the perfect one, but you might ask yourself, can I afford a car? Before taking out any kind of loan, understand what your personal borrowing power is so that you know what you’re eligible for and can steer clear of any loans you can’t afford.
How much car can I afford?
Before estimating the cost of a car, keep in mind that the cost involves more than the loan payment. You also need to consider the operating costs, like insurance, gas, repairs and maintenance, and so on. When asking yourself “How much car can I afford?”, there are a few strategies you can turn to. Let’s take a look below.
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 be between 10% and 15% of your annual income. This rule can help ensure that you’ll still have income available for other living costs, saving, emergency funds and so on after covering your vehicle expenses.
Also if you’re someone who prefers to budget for a car based on salary, than this rule is a great starting point. Check out the below table to determine how much car you can afford based on salary.
|Annual salary||Budget for car|
(10% to 15%)
|$30,000||$3,000 to $4,500||$250 to $375|
|$50,000||$5,000 to $7,500||$417 to $625|
|$80,000||$8,000 to $12,000||$667 to $1,000|
|$100,000||$10,000 to $15,000||$833 to $1,250|
Remember that the 10-15% rule is merely a guideline. If you spend closer to 20%, that’s okay too. Everyone’s budget is unique which means some can afford to spend more on a car.
Find out how much car you can afford using the 20/4/10 ratio
The 20/4/10 ratio is a handy guideline to go by when buying and budgeting for a car. This ratio states that you should put down 20%, obtain a loan term no longer than 4 years, and keep monthly car payments (including principal, interest, insurance, gas and other operating costs) at or below 10% of your monthly pre-tax income.
Make a 20% down payment
As soon as you drive a car off the lot after purchasing it, you lose money to depreciation. This is why a down payment of around 20% is recommended. For example, you should have $2,000 for a car worth $10,000 or $6,000 for a car worth $30,000. Start saving for your down payment as soon as possible. By making a down payment, you’ll reduce the risk of incurring negative equity – which is when you owe more against the car than what it’s worth.
Keep your loan term to 4 years or less
Car loan terms usually range anywhere from 2 to 7 years. However, 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.
Spend no more than 10% monthly on all car expenses
Finally, all costs of car ownership should be 10% of your pre-tax monthly income or less. If you spend more on operating costs, you may struggle to save, spend on a vacation or maintain a healthy emergency fund. Remember that operating costs include more than just the car loan payment, they include gas, insurance, repairs and maintenance, licence and registration, parking, and so on.
The 20/4/10 ratio is meant to be a guideline, not a strict rule. If you can only afford to put 15% down or need to extend your car loan to a 5 year term, that’s okay. This ratio is only meant to help you prepare for the cost of car ownership. Let’s take a look at an example of the calculation below.
Example: Using the 20/4/10 ratio to calculate how much car you can afford
Molly earns $80,000 per year, before taxes and is interested in buying a car. Her monthly salary before tax is $6,667. That means that according to the 20/40/10 rule she can spend $667 per month on all car-related expenses. She estimates how much she’ll have to spend per month on car insurance, gas and maintenance like this:
|Car expenses||Estimated monthly cost|
If Molly can only spend $667 per month on all car expenses, and has to spend $425 of that on car insurance, gas and maintenance, then the maximum amount she can afford to spend on car loan payments is $242 per month ($667 – $425).
Molly starts looking around for cars, and finds a 2017 Toyota Camry at a used car dealership for $13,000. Using the 20/40/10 rule, she’ll have to put a 20% down payment on the car – $2,600 in this case – which she can pay out of her savings.
She then compares auto financing offers for the remaining $10,400 cost of the car ($13,000 – $2,600). Because of her excellent credit score, she’s offered a 4-year loan term at a 4% interest rate. Her monthly car loan payments would then end up being $234.82. That means Molly will be spending a total of $234.82 + $425 = $659.82 per month on all of her car-related expenses, which is within her budgeted amount of $667.
Using the 20/40/10 rule, Molly was able to buy a car that fits within her budget while still being able to comfortably afford her other monthly expenses.
Calculate how much 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 ratio: 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.
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.
Car loan monthly calculatorDecide how much car you can afford by calculating how much your car loan monthly payments will cost.
|Loan terms (in years)|
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.
Find a car loan that’s right for you
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. 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.
Remember to take into account all fees and taxes including the cost of the vehicle when determining how much you can spend on a car. Now that you know what to expect from lenders and what kind of borrowing power you have, you’re ready to compare compare car loans.
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