When you start shopping for a vehicle, you have a ton of things to figure out: the right type of vehicle, the size that best meets your needs, makes and models within those categories, the type of powertrain you want, any extra features and options you might need, and so on. Focusing on all of these things is very important because you want to ensure you get a vehicle that meets your needs and that you’ll enjoy since you’re going to have it for a long time. That being said, none of these things are as important as one essential factor that you should start with: what can you afford?
Although this should be your starting point when shopping for a car, many people overlook it throughout much of their car-buying experience. But if you don’t know what you can actually afford, how can you possibly look at all of the options available to you and decide on what will best meet your needs? Today, I’m going to help you by showing you how to approach your overall budget and what you need to consider while determining what you can actually afford. From there, you can then look at different models and trims to see what will meet your needs without keeping you up at night worried about bills.
Step One: Understanding Your Income
Before we go any further, we need to go over a few basic things to ensure we’re all on the same page regarding budgeting: specifically, understanding how much you make. You’ll see some different terms used when reading about budgeting and understanding your income. Some common ones include:
- Pre-Tax Income – This is the gross income you make, usually yearly, before taxes or other expenses.
- Post-Tax Income – This is what you actually earn after taxes are taken out, usually yearly, sometimes called “Take-Home Pay.”
- Monthly Income – This is what you earn each month, either pre or post-tax.
- Annual Income – This is what you earn each year, either pre or post-tax.
These are all important as you’re figuring things out because you need to understand how much you earn compared to what you really earn in terms of money you have that you can spend. In general, many experts will talk about figuring out your budget based on your annual or monthly pre-tax income for simplicity’s sake. Realistically, you need to consider your post-tax income more since that dictates the actual money you have available.
Step Two: Your Monthly Budget
There are many different budget formulas out there that various experts and financial advisors have come up with, each with its strengths and weaknesses. You’ll probably want to research and read up on different types of budgets to determine which one is best for you. To keep things simple, however, I’ll use a very common type of budget that’s referred to as a “50/30/20 Budget” in order to illustrate how this works.
With a 50/30/20 budget, you’ll want to allocate your income to spend about 50% of your post-tax income on necessities, about 30% on things you want, and use about 20% for savings or paying off debt. In this type of budget, that 50% includes all of your necessities such as housing (rent or mortgage), food, utilities (including internet, phone, etc.), transportation (such as your car costs), insurance, and any other expenses that you require like childcare or healthcare costs. From there, you can spend 30% of your income on things you want, such as gifts for others, vacations or traveling, and entertainment costs. Finally, 20% of what you earn is for savings, to establish and maintain an emergency fund, and to pay off debt.
Still with me? Good…
Step Three: Monthly Automotive Budget
Building off what we just saw, if you go with a 50/30/20 budget, you can see that 50% of your total post-tax income should be used for necessities. This includes your transportation costs, which for most people includes a car. Your car isn’t the ONLY part of this, however, and all of your necessities should only cost 50% of what you earn each month, including your housing, food, etc. That being said, experts understand that transportation/vehicle costs are usually pretty high, and they account for it.
According to many financial advisors, no more than 20% of your income should go toward your vehicle costs each month. That includes any car payments you have, as well as insurance for your vehicle and fuel costs. All of it should add up to 20%, at most, and they suggest that only about 10% of your total income should be for your car payment. In other words, you shouldn’t buy a vehicle with monthly payments of more than 10% of what you earn.
Step Four: Understanding Car Costs
Before buying a vehicle, you should figure out everything involved in paying for it, not just the sticker price or MSRP. There are calculators you can use online that will provide you with estimates of your monthly payments on a loan for a vehicle based on price, interest rate, down payment, and even any trade-in you have. In addition to this, you can look up estimated fuel economy for any car you’re interested in to get a realistic sense of what gas costs for it will be. Finally, call your insurance company to learn what your insurance rates will be for a vehicle that you’re interested in. Models like sports cars are going to be significantly more expensive to insure than a reliable family sedan.
What Does This All Actually Look Like?
Now, let’s do a quick illustration of how this all works. According to the Bureau of Labor Statistics, in the first quarter of 2022, the average weekly salary for full-time workers in the US was $1,037, so we’ll run with that. This comes to just about $54k per year or $4,500 per month before taxes. To keep things simple, we’ll estimate about 20% in total income taxes for $43,200 per year post-tax income, or $3,600 per month.
Following the 50/30/20 budget, this hypothetical average worker should use $1,800 each month for necessities, $1,080 per month on things they want, and $720 each month into savings or for paying off debt. Of that $1,800 each month for necessities – only about $720 of it should go toward vehicle expenses, with a monthly car payment of somewhere between $360 and $540 at most to stay within our budget, which is pretty low. Someone earning less than that is in even rougher shape when it comes to affording a car.
Right now, the average cost of a new car in the US is $47k, which is bad news for our average worker here. Let’s say he has good credit and $10k saved up for a down payment on a car costing $47k; they’ll need $37k in financing. If they get a 4.5% interest rate and pay off the loan in 72 months, that’s a monthly car payment of about $587. We’re way over our budget!
So, what can our average worker do? Even though used cars are expensive right now, they’re still more affordable than brand-new models. The average cost of a used vehicle at the moment is about $31k. Using the same information as above, with $10k for a down payment (or a trade-in of the same value), our worker would end up with a monthly car payment of about $333. Now we’re talking: well within our budget, and things are looking good. This is why used vehicles are so important to so many Americans.
The Hard Part: Sticking to a Budget
Figuring all of this out might seem like a lot, but if you take things one step at a time and use some simple calculators online, it gets much easier. Ultimately, it’s worth the time to recognize what you can afford and set yourself up for success with your finances. Just be sure to actually stick to the budget because the $47k new vehicle might be flashy and impressive, but it’s also going to lead to some sleepless nights and a lot of stress for our hypothetical car shopper. Choose something that meets your needs and fits your budget; then be sure to stick to every other part of your budget in order to keep your finances under control. You’ve got this!