How to Determine How Much Car You Can Afford

When you’re sitting in an auto showroom, the salesperson will pressure you to decide how large a car payment you can afford each month. The more important question, which you should answer before you begin shopping for a car, is “What percent of my income am I currently using to pay off loans?” Financial advisors suggest keeping your total debt payments to less than 36 percent of your gross monthly income.

Example: If your gross monthly income is $4,000, multiplying that number by 36 percent (.36) gives you $1,440. Now add up what you spend on your mortgage loan, student loan, credit card debt and any other debts you already have. Don’t include monthly living expenses such as groceries, utilities and insurance. Let’s say all your existing debts add up to $1,200. This leaves you $240 per month to spend on your auto loan.

The best way to do this is to visit your bank or credit union and ask them to pre-approve you for an auto loan. They will tell you what your credit score is, and help you understand how much of a loan you can qualify for before you enter the whirlwind environment of an auto dealership. In most cases, banks and credit unions offer better interest rates than car dealers.

Ideally, you should put down at least 20 percent on a new car. Selling or trading in your old car can increase your down payment. It’s important to leave yourself enough of a savings cushion to cover three months’ living expenses.

Once you know the monthly payment you can afford, the approximate interest rate you qualify for and the amount of your down payment, you can Google “loan calculator.” These handy tools don’t require any personal information, but they let you enter your numbers and discover the total amount you can afford to spend. It is best to keep the loan duration to five years or less.

Armed with a clear financial scenario, you can shop successfully for a car you can afford.