Even when your monthly car payment fits into your budget, you should never have a car loan payment eat up a large portion of your paycheck. We have broken it down to help you decide just how much is the right amount to spend on a new vehicle.
The average Canadian spends more money than they can reasonably afford when purchasing a new car or truck. A manageable monthly payment should not be the metric you use to justify splashing cash on a $40,000 vehicle that is more than you really need. Purchasing a car is a huge investment, but it’s one that you are in control of.
That is a little nugget that car manufacturers are well aware of.
Turn on your TV at any given time and you will almost certainly see a car ad that is designed to play with your emotions. These ads are all about buying a car that shows people how cool you are or how successful you have been. The automakers are counting on you getting sucked in by these ads and going with the best car available. This is nothing more than a money grab on their part.
What is the right amount to spend on a vehicle?
You can get your hands on a great vehicle and still leave yourself extra money to spend on other things. Saving a couple of hundred dollars on a monthly car payment can mean great things for your budget.
Let’s talk about the 20/4/10 rule
The 20/40/10 rule goes as follows:
- Put together a down payment of 20% of the total price.
- Never finance a vehicle for longer than 4 years.
- Make sure that the total expenses of your vehicle – principal + interest + insurance – is not greater than 10% of your gross income.
Take your latest pay stubs and figure out the monthly gross income for your household, which is the amount that you and your spouse earn before taxes and other deductions are taken off. Once that is done, take a look at your recent auto insurance bills to figure out how much you pay each month. Calculate 10% of your monthly gross, and then subtract your monthly insurance premiums. The figure you are left with is what you can afford to pay on a vehicle.
Let’s imagine that your household gross income is $55,000 and you are spending $100 per month on car insurance, which is around the current national average. Your monthly gross income would come out to $4,583, which, ay one-tenth, equals $458. Take away your $100 insurance payment and you are left with an affordable monthly car payment of $358.
With that amount figured out, you can then use one of the many online car payment calculators to figure out how much you would pay per month when paying the total cost of a vehicle over the course of 48 months. If the calculator asks for the interest rate, use 4.35%, as that is usually the accepted rate on a 48-month loan.
What you can expect to pay
If you have a good credit score, you will probably pay less than average for financing. When using your auto calculator, enter in the down payment amount that you intend to put down, as well as the expected trade-in for your current vehicle, assuming you are going that route. You will also be asked to enter the sales tax for your area, which may be different for vehicles than it is for everyday purchases. With all of that information entered, hit the calculate button and you will get the total purchase price that you can afford to pay.
Are there situations where you can reasonably spend a little more?
There are indeed. Some dealerships will offer a rebate that can be applied to your down payment. Alternatively, your great credit score may mean that you are given financing at a lesser amount than the going rate. The bigger the down payment and the lower the interest rate, the better the vehicle you will be able to afford.
There is a caveat here, though, and it’s that dealerships may try to suck you into a longer term than 48-months in order for you to get the rebate or the lower insurance rate. No matter how sweet the deal may seem, you need to stick to the 48-month plan, as going with a longer term means paying a whole lot more in interest over the term of the loan. The only person that wins in that scenario is the lender.