Remember when we all got together and discussed whether my boyfriend should trade in his rust bucket for something a little less… rusty? Well, the car is still going strong, but with an upcoming move out of state and a new job on the horizon, the rust bucket’s retirement looms near. We’re not rushing off to the dealership to test drive BMWs or anything yet… well, maybe, but only because we like test driving BMWs!
While it’s not on the top of his list of things to worry about, Zack is still making preliminary plans for replacing the car. It’s a good idea for anyone to start thinking about this long before you actually need to – give yourself time to really evaluate what you can afford, and what you want, so you can save up a down payment and be fully prepared when you finally walk into a dealership (or a used car lot or start answering ads on Craigslist… whichever).
How much money is appropriate to spend on car expenses each month? Heuristic (“rule-of-thumb”) percentages don’t work for everyone, but they’re a good place to start, especially if you’ve never had a car payment before. I went a-Googling to see what heuristics I could find… but I wasn’t entirely impressed with what I found.
10% of Gross Income
According to a post on the Letters Unlimited blog, columnist Liz Pullium Weston wrote in one of her “Money Talks” columns that "Most people are smart to limit their total transportation costs, including car payments, insurance, maintenance and fuel, to no more than 10 percent of their gross income." The Letters Unlimited blogger, Tammy Rosboril, concluded that this is unrealistic for most people, and I tend to agree. If your car is paid off already, this number would be easy to achieve, especially if your gross salary is $50,000 or more. But throw a car payment into it, and it all falls apart… that is, unless you spend nothing on gas and let the car sit in the driveway all the time. Or you make a lot more money.
Using a $50,000 gross salary, a 10% figure gives you $5,000 per year for car expenses. Tammy Rosboril assumes $213.67 eaten up by gas (a high number, but she was calculating this during $4/gallon gas prices, which we may see again), $83.34 per month for insurance, and a conservative $250 per year for maintenance… which would leave you only $98.82 for a car payment. Even with a large down payment, that doesn’t buy you a lot of car.
Total Debt Payment No Greater Than 36% of Gross Income
Consumer Reports offers a different take on the issue, choosing to look at debt payments as a whole. Interestingly enough, they include rent as a “debt” for these purposes, which makes sense because if you had a mortgage, you would include that as a debt. So total debt payments, including rent/mortgage, car payment, credit cards, and any installment loans should all total up to less than 36% of gross monthly income.
Which is made completely insane by the metric I use to judge housing costs: total housing costs should be no more than 27% of gross income. So let’s say that your rent is 25% of your gross income, and utilities and such are 2%. If we ignore utilities, that only leaves 9% of your gross income for all debts, which is less than the 10% above from Liz Pullium Weston… and if you have student loans? You’re screwed.
Real Life
So, forget heuristics. If you find one that works for you, go with it. Otherwise, figure out what you need and what you feel comfortable with. Taking things back to my boyfriend Zack, here’s the deal: his rent costs will be 22.4% of his gross income. He doesn’t have any other debt payments (which makes me very jealous, what with my huge student loan bills), so he’s got more wiggle room than most of us. If he uses the 36% rule, he’s got 13.6% of his gross income to work with.
13.6% of Zack’s gross income is probably enough, especially if he comes up with a decent down payment. But it sort of proves my point about the 36% rule not working for most people – most people aren’t like Zack, because most people have student loans or some other debt besides housing. And many people spend a greater percentage of their income on housing than he does.
(One thing he will have to keep in mind is that he’ll have to pay a car tax while living in Virginia, a point that was brought up by reader Kamantha in a comment on my earlier post about ditching my car entirely.)
What do you guys think? Is there a good rule-of-thumb out there for how much to spend on transportation? Let me know in the comments!
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16 responses to “How Much Should You Spend on a Car?” 
We are living overseas, and recently a friend met with one of the wealthiest men in SE Europe. He could literally afford any car he wanted, car insurance and gas mileage and the like would be a complete non-issue. He drives an old (but reliably maintained) Eastern European sedan. It’s ugly, nobody gives him a second glance, it leads to no attention from the police, and that is how he wants it. No, I don’t want an Eastern European sedan, but I wonder if there is something to learn from this. Maybe if it is kept safe and reliable, it’s getting the job done. It isn’t a mindset for everyone, of course, but I thought it was interesting!
Jerry
People spend far too much on their cars.
Personally, I drive a beater, a literal piece of junk. But the thing is, even with it half wrecked, it will take me to just as many places as a brand new car. There’s no reason to spend a lot on a car, especially when they devalue every time you turn the thing on!
First I have to say that I think saving up and paying cash for a car is the best way to go. No car payments makes life much easier.
If you can’t wait to save up, then I’d say that you need to buy a car that you can afford to pay off in three years. So whatever payment you can afford in your budget each month, and times that by 36. You’ll have the shopping range to look for when you buy a car. If you can afford $250.00 a month, then you should look for a car in the $9000 range.
New cars lose value so quickly, but you can get decent used cars that will last a long time as well. If you have a down payment saved up you can afford a nicer car.
a good auto dealer will work with you to get an affordable down payment and monthly payment. if you can’t afford a lot down, go for a longer finance term. you’ll pay a little more in the long run, but the theory is that you’ll be making more money by then so it isn’t such a big deal.
I respectfully disagree, John. First of all, I don’t think that most auto dealers will have your best interests at heart. I don’t think they’re all entirely sleazy, but their job is to sell you as much car as they think you can afford, not what you really can afford. And a longer finance term isn’t something I would recommend, either – you’ll pay a lot more in interest, and you’ll have less equity in the car if you have to sell it early for some reason.
I also think the theory that you’ll be making more money in the future is a little dangerous. Many recent grads use this to justify buying a car they can’t afford, and it stunts their other goals, such as a down payment for a house, travel, or a nice wedding.
If there is a way to get the discount on fuel, why don’t maximize to using it. This will sure reduce our spend on car. Also be careful when buying a car. Don’t buy old car. It take much money to maintain it.
Car finance is real tricky. I’ve always bought used because new is just too expensive but there’s a limit to how used the car can be. I generally go for something that’s in the region of 3 to 5 years old but still in excellent condition. These cars are usually half the price of a new and still pretty economic and reliable.
car financing is alwyas a big problem. I used to have a car but I found I could not afford it at the end. Well, say good bye to it. I don’t want to be that poor.
10% of gross income. I think I am way too conservative on mine then. I am like 7% something for my car payment. I guess less is better, so I can save more money for other things and also reduce my car repair and maintenance costs.
If you want to save money or get out of debt it is ridiculous to buy a new car.
10% of gross income will buy almost everyone a reliable used car.
I personally disagree about some of your numbers. Firstly, while 10% of gross on all car expenses total is a little ridiculous for most people (I am easily within that but, then again, I made over $400,000 last year, so…) but I think it is intended to mean ‘10% of gross income on car payments’, which would mean that if you made, for example, the $50,000 a year you used, $5000 per year could go to car payments. 60 month simple interest loan at 8% (I personally have good credit so mine wasn’t that high back when I financed my vehicles, but then again, this is not about me) would give you just over $20,0000 of loan. Add in perhaps $2000 for a down payment and a couple grand extra to pay for the other expenses (tax, title, first months payment…) would give you a car stickering around $22,000. This rhymes fairly well with the estimate of 1/2 of you annual salary for a vehicle, maximum (obviously you want to spend as little as possible while having a vehicle that meets your needs and as many of your desires as is financially practicle).
Second example, I have always heard 28/36% front end/back end ratio (28 housing, 36 total). The common and usually excepted method for determining housing is mortgage payments/rent plus property tax (if applicable) plus insurance. I almost never see utillities included in that 28% as they are so variable from person to person, while mortgage payments or rent are not usually (obviously, credit rating will affect the mortgage rate… but I don’t won’t to write an article here, only a comment). So, this way, 28% of $50,000 on housing (typically buys around 2.5 times your salary, depending on interest rate and how much you put down) leaving you with $4000 for vehicles. If you still have that $2000 for a down payment plus the extra for the added fees, you could buy around an $18,000 vehicle on a 60 month loan, or about $15,500 on a four year loan. I think this should be enough for just about anyone to find a satisfactory vehicle. Maybe not new, but certainly not a rust bucket.
Another factor is, say you buy a new $20,000 vehicle on a four year loan. With $2000 down, your monthly payment will be about $430. If you keep the vehicle for, say, eight years, you can save 48(number of months after the loan ends) * $430 (monthly payment that you could hopefully afford during the loan period) = $20,640. Suddenly you can afford to pay cash for your next vehicle. If you then keep that vehicle for eight years, you only need to save 1/2 * 430 = $215 per month to pay for you next one in cash (or alternatively, your next vehicle could be $20,640 * 2 = $41,280, ignoring higher insurance and other costs that that would bring). This is ignoring inflation because I am assuming you put the money in a CD, bond, or low risk mutual fund to hopefully at least keep up with inflation, if not exceed it.
Thank you for the article and keep up with the good work.
Thanks for your comments! While I agree with you that the numbers make more sense your way, every “expert” I’ve seen seems to use them the other way – 1/10th of your annual salary for the price of the car you should buy, or the Consumer Reports idea of using no more than 36% of your gross salary for debt payments. But I do agree with you – neither of those metrics provides enough leeway for most Americans to afford a decent car, which leaves them particularly useless rules of thumb. I’d rather people run the numbers and look at their individual finances than rely on these bunk heuristics.
I guess the problem might be that those “experts” make just a little too much for their own good. I know I certainly do, but (you knew that was coming) I haven’t always had as much, and it is incredibly unrealistic to assume that everyone is wealthy. After all, if we all had a great deal of money, there would be no need for car loans at all!
Anyway, keep in mind that Consumer Reports says 36% of gross for DEBT payments. I wouldn’t consider utilities on the house or gas for the car ‘debt’ (unless you put them on a credit card that is…). I of course agree with you that everybody should look at their own numbers, but then again, what do rules of thumb exist for but for basic reference to get you in the right general neighborhood? If you make $1,000,000 a year, your acceptable level of debt may be a much higher percentage than somebody making $30,000 per year. Also, I think it would be wise to not wish that everybody could run their own numbers, because if they could, who exactly do you think would be reading this?!
Also, I find it very unrealistic that everyone uses gross income as a basis for estimation. I personally use net for all of my expenses and I think that if you use the 36% rule applied to net income, most people will not have too much trouble. For example, if you made $30,000 per year take home, you could (according to CR) use $10,800 per year towards debt. This leaves you with $19,200 per year for food, clothes, gas, utilities, savings, recreation, and health purposes. Since the average American (I’m assuming you’re single in this example) spends less than $6000 per year on food (source is a U.S. census, I can provide a link if you want) this leaves about $13,200 per year for those other things. If you say $700 per year for clothes, $500 recreation, and $2000 for health, you are left with around $10,000 for gas, utilities, insurance, savings, and other miscellaneous things. That $10,800 would get you a fair apartment (here in Austin, TX, a one bed one bath apartment in a nice, central part of town will run you about $650 a month for a two year contract) and a bit left over for a used car. I think this is perfectly reasonable so long as you are single and don’t have particularly high end tastes. I’ll shut up now, and sorry for writing such long comments, I just find this topic one of particular interest.