Finding The Perfect Car

How Much Car Can You Really Afford?

6 January 2016 by Julian Moya

Auto repossession is a far too frequent occurrence in the United States. In the first quarter of 2014, for example, about 1 out of every 172 financed vehicles was repossessed by creditors when the debtors fell behind on payments. Part of the issue is that many people end up taking on car payments they can't afford. Here's what you need to know about calculating the amount of car you can afford to avoid falling into this type of situation.

Debt-to-Income Ratio

Many personal finance experts recommend that the total amount of debt you owe should be no more than 43 percent of your income. This is to protect your credit score as well as ensure that you have enough money left over to finance savings projects such as retirement and college tuition for children.

Ideally, then, the maximum car payment you can afford would be whatever is left over after you calculate what 43 percent of your income represents and subtract your current debts. For instance, say you make $54,000 per year ($4,500 per month). Thirty-six percent of your income would be $1,935 per month. If your monthly debts equal $1,600 (rent, credit cards, and student loans), then the maximum car payment you can afford would be $335.

That may not sound like much, but $335 per month on a 60-month loan term equals $20,100. That amount can purchase a fairly decent used or a new economical vehicle.

Don't Forget Other Car Ownership Requirements

However, don't forget to add in other debts associated with purchasing a vehicle such as:

• Auto insurance
• Annual loan percentage rate
• Maintenance
• Licensing and taxes

These should also be factored into the 43 percent debt-to-income ratio, which may reduce the actual monthly payment you can afford. For instance, if insurance, interest, and licensing add another $150 to your debt load, then the maximum car payment you can afford will be $185. This means that you should be looking at cars valued at around $10,000 to $11,000 (based on a 60-month loan term).

If that amount is just too low for you, there are a couple of things you can do to afford a more expensive car. The first would be to trade in an existing vehicle. If you have a vehicle worth $3,000, then you would be able to afford a $13,000 to $14,000 vehicle. You can also make up the difference between the purchase price and what your budget says you can afford by making a bigger down payment.

Although it may be tempting to exceed the recommended debt-to-income ratio so you can purchase the car of your dreams, doing so may jeopardize your financial health. It's best to stay within your means to avoid the embarrassment of having your vehicle repossessed if you become unable to make the payments. For more information, consider contacting dealerships like Western Avenue Nissan.

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