How much should you spend on a car? Probably not as much as you might think.
You can spend between 10% and 50% of your gross annual income on a car. That’s a big range, we know, so if we had to set a rule, it would be this:
Spend no more than 35% of your pre-tax annual income on a car.
Lower is better, but we recognize personal finance is personal. You might spend more only if you can securely pay cash for your vehicle and the kind of car you drive is important to you. You can explore how much car you can accord in our car affordability calculator below.
You can limit how much money you spend on your car by:
- Saving up and paying cash.
- Buying used.
If you do both of these things, you’ll save thousands of dollars compared to financing or leasing a new vehicle.
That said, sometimes you need transportation before you have cash saved to buy a car. So there are some additional rules to consider when you get an auto loan.
Use our car affordability calculator to find out your maximum payment
Do you have a car to trade-in? How’s your credit? Have you been socking away money for a new car for years? These factors will affect how much of the car you’ll have to finance and how much you’ll have to pay in interest.
Use our car affordability calculator to see how your down payment, trade-in, and auto loan interest rates and terms affect the amount of car you can afford.
Compare car loan offers
The last thing you want is to be pressured into an expensive loan by a dealer when purchasing your car. Car salesmen are masters of the deal, and you may find yourself paying much more than you bargained for, or locked into a loan with unfavorable rates and terms if you’re not careful.
To prevent that scenario, you should be sure to come prepared and armed with as much information as you can. Comparing offers from several different lenders can help you to figure out what rates you qualify for, and will allow you to make informed decisions about financing your purchase. Comparing rates from multiple lenders will also help to ensure that you’re getting the best rate possible, which can save you a lot of money over the long term.
Loan comparison tools like Monevo are a great way to compare different lenders for free online. Monevo lets you look at loan offers from over 30 different banks and lenders in order to find one that works for you and your budget. The process only takes a minute – all you’ll need to input is how much you’re looking for, what the loan is for, and what your estimated credit score is. Then you’ll have a list of lenders organized in an easy-to-read list. Plus, this whole process doesn’t affect your credit score!
LightStream is an online lender to consider if you’re on the hunt for an affordable auto loan. In addition to a simple, uncomplicated online application process, they also offer to beat any loans you find from competing lenders by at least .10 percentage points.
With loans ranging from $5,000 all the way to $100,000, you’ll easily be able to find terms that work for your personal needs.
When comparing loan offers, you should make sure that you’re not comparing apples to oranges. Only compare loans with similar amounts and term lengths in order to get a clear picture of just how good a deal they are, and remember, don’t take on a bigger loan than you can afford.
The three rules of car financing
The rule of thumb when it comes to smart auto financing is the 20/4/10 ratio.
According to this rule, when buying a car, you should put down at least 20%, you should finance the car for no more than 4 years, and you should keep your monthly car payment (including your principal, interest, insurance, and other expenses) at or below 10% of your gross (i.e. pre-tax) monthly income.
Why is the 20/4/10 ratio smart? Here’s why:
1. Put at least 20% down
According to Edmunds, a new car loses 9% of its value the second you drive it off the lot. By the end of the first year, it’s lost 19%. (This is why buying used is the way to go.) If you put less than 20% down, you risk becoming underwater on your car loan – meaning you owe more on the car than it’s worth – almost immediately.
If you need to sell the car before the loan’s paid off, you’ll have to come up with the difference between the car’s value and the balance on your car loan. Ditto if you get into an accident and the car gets totaled.
2. The term of your car loan should be no more than four years
The longer the term of your loan, the more interest you pay. The longer your loan term, the longer you’ll have to meet your lender’s insurance requirements, which often means higher rates.
Plus, by the end of four years, your car will have lost a lot of its value, and you won’t want to still be paying it off.
Four years is the maximum most personal finance experts recommend. If you can swing paying off your car in three years, that’s even better. If you feel you absolutely must stretch your payments further, you could get a five-year loan, but never longer.
3. Your total car payment (interest, principal, and insurance) should not exceed 10% of your gross income
Your dream car isn’t worth having if your monthly payments eat up all the extra room in your budget. Staying below 10% means you’ll have money to put toward other things – like an emergency fund, a down payment on a house, or a nice vacation.
It also means a change in circumstances – say, a pay cut or a job loss – won’t turn your new wheels into an albatross around your neck.
Rules aside, everyone’s situation is different
Yeah, yeah, you might be saying – but what if I need a car now? And not some junker, but a reliable one that’ll get me to work on time?
The 20/4/10 guideline is just that – a guideline. If you don’t have the cash for 20% down, and you can’t take the bus until you save some up, then put down less. (And please, please buy used!) If the only way to get your monthly payment down to 10% of your income is to extend the life of the loan, then do it. (But consider a cheaper car first!)
Also, take advantage of our amazing resources to help you find the best car insurance for your individual needs. Get a quick quote from car insurance companies in your area using this tool:
Shop for car insurance
Keeping your monthly payment under 10% of your gross income is the most important thing. That’s what’s going to keep you from feeling pinched and stretched. Here are some of the top insurance providers on the market today that are operating in your local area. Find the policy that best suits your needs.
How do you know if you’re paying too much for insurance?
Gabi can help you find out. Either provide a link or PDF of your existing insurance policy and Gabi will shop around for a better deal. If you like the quote you’re offered, you can move forward and start saving money. In fact, Gabi customers save $961 on average per year.
If you prefer to work with an agent, Allstate can help you save money. If you’re an excellent driver, this insurer may be a great option for you. Sign up for Drivewise and earn as much as 25% back for every six months you go without an accident.
Those who have multiple types of insurance may want to look at Liberty Mutual. You can save big by bundling your auto policy with your renters, homeowners, or condo insurance. Their website makes it easy to get a quick quote to find out if you can save money by switching to them.
Related: Should You Ever Buy a Brand New Car
Related: Tips for Saving on Your Car Loan
How does the car affordability calculator work?
The above car affordability calculator uses a conservative but solid assumption about how much car you can afford. Whether you’re paying cash or financing, the purchase price of your car should be no more than 35% of your annual income. If you’re financing a car, the total monthly amount you spend on transportation – your car payment, gas, car insurance, and maintenance – should be no more than 10% of your gross monthly income. The calculator doesn’t ask for gas and insurance values but will begin to reduce the purchase price you can afford if the terms of your loan (interest rate and length) make your monthly payment exceed 10% of income.
Why is my amount so low?
Cars may be necessary transportation, but their quick depreciation means spending more than you have to on a car is a fast way to make your hard-earned money disappear unnecessarily.
A bank or car dealer will likely approve you for much more than your result on our calculator. But what the dealer says you can afford and what you can actually afford are very different. Remember, if you stop paying your car loan, the bank repossesses the car. Either way, they win.
The result of our car affordability calculator shows you a sensible amount to spend on a car. And yes, it might be far lower than you might think. But remember that the more money you spend on a car, the less money you have available for everything else – housing, food, travel, entertainment, paying off debt, and saving.
Your car is one of your largest monthly expenses – the lower you can keep that expense, the faster you’ll be able to build wealth in other areas.
What if I’m paying cash?
Paying cash for a car is always best. If you’re able to, how much you have saved and what you’re comfortable spending on a car can guide you rather than the 35% of monthly income. That said, you may want to check out this post that talks about the wider range of how much you should spend on a car based on your annual income.
Get free dealer pricing on your new car
Use Edmunds to get dealers to fight for your business! Pick your car and see the best price before you leave home.
Compare car loan rates and get approved for financing before you shop
Easy 3-minute pre-approval. No obligation. Past credit problems OK.
Check your credit before you apply!
Avoid surprises and get the interest rate you deserve. Learn how to get a truly free credit score in minutes.