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.
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!
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!
Four Eyes says
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.
John C. says
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.
Actually I agree with you Stephanie. Most car dealers aren’t sleazy, some are, but most aren’t. Regardless of the sleaze factor, they will all sell you as much car as you will take and that the bank is willing to finance for you. John C is obviously in the car business. Take a short term unless you are planning on driving that car to the grave. If you finance a car for 72 months and trade it in 3 years, say hello negative equity. The best plan is to buy a new car on a promo rate of 0% 1.9% even 2.9%. Put about 20% of the total cost down, and finance it for no more than 5 years, 4 if you can swing the payment. That will put you in a good position equity wise, and if you decide to keep it for a long time, you will be driving payment free after 5 years with (on average) 70K miles on your car, most cars today if properly maintained will go well over 200k. Thats about 7-8 years of free driving. Good Luck All.
Thank You. This was really helpful for me.
Ruri@Free article submission says
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.
Anon @ Factory Service Manual says
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 agree with this. The front/back ratios are based on what reports to your credit, not what you spend. In the mortgage industry they do not take into account utilities. CR number is similar that is does not take into account insurance or gas. As a general rule of thumb (assuming it isn’t your first purchase) 3X salary is what you can afford for a house (although you can qualify up to 4X if you have very low debt) and 1X salary for car purchase. The idea being that you would have equity from either a previous home sale or car sale. My income is around 130K (household) both my wife’s and my care are paid off. If we use the 1X rule for car purchase at 1/2 household that leaves 65K purchase price, 25K in down payment from equity leaves 40K to finance. Over 5 years @5% is about 750/month; which is very close to CR’s 13.6%. If properly taken care of and you don’t drive 100K miles in a week your car when paid off should have equity of about Â½ the original purchase price (32.5K in our case).
I don’t recommend this thought… Pay cash and drive it until it is dead… Getting the car fixed will usually always be cheaper than car payments.
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.
richard a says
Learn how to shop for a car. Learn how to maintain a car beyond just watching the fluid levels and the idiot lights. shop for a used car from a private seller rather than dealers. Save your own money every month just as if you were finacing it,then buy it on cash four years later. You’ll save money on registraion and insurance because your car’s paid for. By the way this goes for the ladies too.
As a car fanatic and a life long cheapskate, I have always struggled with how much to spend on a car. So, here is my take on the topic of how much to spend on a car – the car vs house calculator
The general principle is that the annual cost of your car versus the annual cost of your house should be proportionate to the amount of time you spend in each.
Take a look:
I just purchased a new BMW M3! I had to do it since owner of the company got an used 335xi! I always had a thing about being better then the owner of the company in terms of affuence and all. It a 120 employee company and I work in the warehouse as a stocker. It kind of an entry level postion. But he was shock when I showed him my car! He said “how can you afford the M3”? I just smiled; since his BMW is three years old and my is brand new! $90K
I had to deal with the financing of it; but it was worth it! I pay about 75% of my take home pay for monthly payment on the M3 and had to extend it to 72 months instead of the usual 48 month time frame. Insurance is super high too since I am only 19 years old!
Lol I like your troll. The sad part is that some people will think you’re serious. I wasn’t too sure myself until I saw your name.
Well played, sir.
Car Dealer Columbia says
I think it depends on how much you research a car, the reliability factors, and of course, money situations. For some it’s a matter of finding the right used models and for others it’s the bright, shiny new auto that gets them going. I do agree with the 10% of total income expense for a car, because every shopper could find a very good car with that model of payment.
I am alowed to spend 2.5% from my gross income
I think the 10% rule is way to low. It is unrealistic if you need to have a car payment.
Actually, it’s not entirely unrealistic, just limiting. As you’ll see in my comment below to Roddy, I just got a used Camry yesterday, and the payments will be less than $200/month, which leaves me enough wiggle room in the 10% to pay for gas, insurance, and maintenance. Was I able to afford a new car, or something flashy, within those guidelines? No, not at all. But I have something reliable now, within my budget.
So I’m supposed to buy a reliable, SAFE, and well maintained car for 2K? Yea right! Grad college to make that 20k too. pssshhh
Yep, affording a car on $20,000/year is gonna be tough. You’re faced with two options, really:
A) Buy a beater for about $2000. You will have to spend a lot of time shopping for one, checking Craigslist and other online listings often and you’ll want to make friends with a mechanic that can check the cars out for you. The car probably won’t last you too long, but if you do your research and find an older car (and I’m talking like, 1990s older), you’ll find something that gets you from Point A to B for a while.
B) Spend more, and put a much higher percentage of your income toward your car. You’re most definitely still going to need to look at used cars, but by spending more, you can find something a little nicer and newer, that will last you longer. Just yesterday (literally yesterday – I’ll be writing a post about it soon) I got a 2004 Toyota Camry for about $11,500 total. I put $2500 down and financed the rest, and the payments are less than $200/month. It would be a crunch for you to do something similar, but if a better car is important to you and you can find a way to limit all of your other expenses, it can work.
I bought my 1966 Buick Lesabre (2 door, 340 v8) from an elderly woman off Craigslist. Now I get 18mpg at best haha, but 1400 bucks for a 45 year old car that hasn’t broken down since it came off the showroom floor (I’ve put 20k miles on it since I bought it two years ago, it just hit 80,000 yesterday.) seems like a good deal. It just doesn’t break! I changed the radiator (200 dollars), and brake booster (under 100), but both as a precaution rather than need. Also switched ignition from a points-based system and got slightly better mileage out of it. It has power windows and ac. Laugh at the old dinosaur if you want, but it’s quick enough to merge (260 horsepower and 375 ft lb torque wildcat package), is more comfortable than my parents 2005 highlander, 2004 tundra, 95 Camry, and it’s a reliable classic. Oh, and if safety is a concern, I hit a 91 Volvo 240, totaled the Volvo and I have a barely noticeable dent and a bad scratch. It also totaled a late 90s civic that ran into my rear bumper, my chrome bumper sustained nothing more than a scratch. Best part? No payments lol
I think its an investment to have a reliable car but it will almost always be a depreciating asset, which sucks.
I think you should buy a good car. If you don’t have much money you’d better save enough money and then buy it. I agree with @Ben