There are many factors constraining your car buying decision, but none are as important as your budget. Based on the money you currently have and the money you make in the future, you’ll be limited in which cars you can buy.
But what’s the best process for determining whether a car is truly affordable based on your financial circumstances?
Leasing vs. Buying
One of the first questions you should ask is: should you lease or buy your car? Leasing and buying are very different options, and they enter into your affordability calculations very differently.
When buying a car, you’ll typically either pay all in cash or take out a loan to fund the purchase, at which point you’ll make monthly payments until your loan is paid off. In exchange, you’ll have total ownership of the vehicle, which means you can use it however you want, and you’ll be responsible for taking care of it.
If you lease a vehicle, you’ll pay a fixed monthly fee for the privileges of using it. Someone else will own the vehicle and will be responsible for maintaining it, and you may be subject to restrictions on how you can use the vehicle.
Buying New vs. Used
Similarly, you should consider whether you want to purchase a new or used vehicle. Used vehicles are often in great condition, rivaling the performance and reliability of new cars, but they can save you a lot of money. Make sure you consider both when running calculations.
General Factors to Consider
To determine the affordability of a vehicle, you should consider the following factors and more:
- Income. First, think about how much income you have, both in terms of gross and net income. Ideally, your vehicle expenses should represent only a small fraction of your total expenses.
- Typical expenses. You also need to think about your typical expenses. How much are you currently paying for housing, groceries, utilities, and other essentials? How much can you tolerate adding to your budget without causing any issues?
- Existing debt. The average person should strive to have a debt to income (DTI) ratio of 36 percent or less; that means you should have debt obligations totaling 36 percent or less of your gross monthly income. Accordingly, if you have too much debt already, you should avoid taking on more in the form of a car loan.
- Taxes and secondary expenses. The price of the car is only the beginning of the expenses you’ll need to plan for. Don’t forget to factor in expenses like taxes, insurance, and fuel.
Affordability When Paying in Cash
If you’re paying for a car in cash, affordability is largely a matter of how much money you currently have. Generally, if the following statements are true, you’re likely well able to afford this vehicle:
- You aren’t pulling from retirement accounts. It’s not impossible to pull money from your retirement accounts to fund the purchase of a vehicle, nor is it always a bad idea. But for most people in most situations, this is inadvisable. Your retirement funds are meant to grow untouched until you retire.
- You aren’t taking out massive or high-interest loans. It’s possible to take out loans or cash-in investments to secure the capital necessary to fund a vehicle purchase. But sometimes, this puts you in a worse financial position.
- You aren’t compromising your ability to handle other expenses. You should never purchase a vehicle if it means compromising your ability to handle other expenses. If you can keep making ends meet this way, feel free to move forward with it.
Affordability When Financing or Leasing
When financing or leasing a vehicle, you’ll need to consider how much you’re going to spend on a monthly basis and how this fits into the rest of your budget. The standard recommendation for car budgeting is to spend no more than 10 percent of your net, take-home pay on your car payment.
However, you should also make sure of the following:
- You’ll have plenty of money for other expenses. Assume that you now must make monthly car payments. Are you going to have plenty of money to handle your other expenses?
- You’ll have extra money left over most months. Given the new car payment, are you still going to have extra money left over most months? Are you going to be able to handle emergencies?
- You have reason to expect stability in the months and years to come. Do you have a good reason to think that your income and expenses will remain consistent in the near future?
Car affordability can be complicated to calculate. But as long as you’re thinking ahead about your income, expenses, and the financial burden of this vehicle, you’ll be in a better spot than most.