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Auto Loans: How Much Car Can You Afford?

Auto Loans: How Much Car Can You Afford?


Planning to buy a new car or a used car is a big decision as it affects your monthly budget and financial situation.  Purchasing a car might be one of your major financial commitments, needing you to figure out how it fits within your budget and whether it is affordable.   Your budget dictates the price tag to the vehicle you can afford and not necessarily the car you want.

To illustrate, you want to buy a vehicle that costs $40,000/- but your income can only afford a car worth $25,000.  Therefore, the car you want is not within your reach, thus, forcing you to reconsider your planned purchase.  Non-payment of auto loan leads to your financier repossessing your vehicle. How can you calculate the amount you can afford to purchase your car?

man holding car keys next to car

1.  Calculate Your Monthly Net Income

Financial advisers typically advise you to spend less than 10% to 15% of your monthly take-home income on your car loan payment.  That means that your first step is to calculate your monthly net income against your monthly expenses.  Doing so will help you determine how much extra income you can dedicate towards auto loan repayments and transport costs.  Transport costs include fuel expenses, car service maintenance and repairs, and car insurance.

So, if your monthly net income is $4,000, plan to spend $400 on your car payment.

2.  Check Your Credit Score

Your credit score contributes to determining your annual percentage rate (APR) payment on the auto loan.  The higher your score, the less you pay for loan interests.  Keep in mind that the interest rates for pre-owned vehicles are higher than interest rates for new cars.   Be realistic about the length of time you wish to pay off your auto loan.

According to CNET, buyers in America negotiated to repay their car loans over long periods to make cheaper monthly payments. In March 2020, auto loan repayment periods were approximately 72 to 80 months of financing for new vehicles.

Negotiating for a longer-term repayment schedule reduces your monthly payments.  However, the final amount of interest paid for your car increases.

3.  Establish your Target Price

Once you have determined the amount of auto loan you can afford, set your target price for purchasing a vehicle.  It is essential to factor in 10% for the sales taxes and fees.  For example, your target price for buying a car is $ 25,000.  At the dealer's, you see a car with the advertised price tag of $25,000.  Calculate the cost of the vehicle to include an additional 10% to the advertised price to get the total purchasing price of $27,500, which stands above the price you can afford.  Therefore, target a car whose price is approximately $22,500.

4.  Make a Down Payment from Your Surplus Income

Make a down payment on your auto loan as it reduces the length of time to pay off the loan.  You can use a trade-in as a down payment if you paid off your old car or you have equity.

For more financial advice for auto loans, contact 1st Community Credit Union or give us a call at 888-706-1228.

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