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So you are about to make a major financial decision and buy a car. Beyond knowing what type of car you want, you first need to figure out what you can comfortably afford.
While buying a car is faster and often easier than getting a mortgage, there are always costs you need to budget beyond the selling price of the car itself, such as fees and taxes on closing and insurance payments. We’ll show you how to get ready to buy the right car for you – without breaking the bank.
3 Steps to Determining How Much Car You Can Afford
The average cost to own a car is over $ 5,264 per year, according to Move.org, which works out to almost $ 440 per month. However, this cost can vary from state to state (Michigan tops the rankings with an average of over $ 9,300 per year, or $ 775 per month). So you need to make sure that you can afford a car on a monthly basis, not just at the time of purchase. Here are some basic steps to help you check your budget ahead of time.
1. Calculate your monthly net debt income
One of the very first steps to take is to compare your monthly after-tax income (net income) to your monthly expenses. Figure out your net monthly income after paying off existing debts like credit cards or mortgage, utility, and insurance bills, as well as average health, child care, and living expenses. This should give you an accurate picture of your cash flow once all of your obligations have been met each month.
It is more important to focus on the type of car you can afford versus the one you want. Because if you can’t buy the car and you don’t make the car loan payments, the lender can repossess your car.
Financial planners recommend that your car loan be limited to 15% of your monthly net income. Adding gas, insurance, and maintenance will also increase your costs by a few percentage points.
So, for example, if your monthly take home pay is $ 3,000 per month, the 15% threshold would allow a monthly payment of $ 450 for a car loan. By limiting your car payment to 15% of your monthly net income, you’ll likely still have some savings to cover sudden expenses, like the car in need of repair.
2. Check your credit score
The amount you pay for a car loan in terms of annual percentage rate (APR) is determined by your credit score. The higher your score, the less interest you pay on a loan.
Your FICO credit score is determined by these factors: your payment history; amounts due; length of credit history; new credit and credit mix. The FICO score is based on credit reports compiled by the three major credit bureaus: Experian, Equifax, and TransUnion.
To understand where you fall in the FICO credit score range of 300-850, check your score for free.
3. Evaluate your extra money for the down payment
The down payment for a car is the money out of your pocket. While some car dealerships and lenders offer no-down financing, it’s best to set some money aside to help cover closing fees and taxes and / or to reduce the loan amount. Putting money aside will also reduce the total term of the loan.
For example, let’s say your budget is $ 20,000 and you’ve found a vehicle at that selling price. If you borrowed $ 20,000 at 4% APR and paid off the vehicle over 60 months, your monthly payment would be around $ 368. After 60 months, you will have paid a total of $ 22,100, including $ 2,100 in interest.
If you had a $ 3,000 down payment, your monthly payment would drop to around $ 313 and the loan total plus interest for the life of the loan would only be $ 18,785.
How to explore your financing options
Start with your bank or credit union
Traditional lenders like a bank or credit union are a great place to apply for a car loan, as they often have lower rates or special offers for customers who already do business with them. You can also get a pre-approval letter from your bank or credit union before you start looking for a car, which will give you a better idea of what you can afford.
It’s a competitive market among lenders, so try to check out at least two or three quotes from different lenders. It also helps your negotiating position.
This is especially true if you are already a client of a bank or credit union and have a good history of borrowing from that institution. They can do a quick assessment of your financial history and credit profile because they already have them in their system. If all goes well, they can give you a letter stating how much money you are allowed to borrow, which you can use to buy a car, or negotiate with other lenders for a better deal.
Consider loans through a dealer
Auto dealerships, especially if they are affiliated with manufacturers like Ford, General Motors, Honda or Toyota, have access to retail lenders who arrange loans for qualified borrowers on site at the dealership. But in addition to these large creditors, most dealerships also have access to national and regional banks that offer auto financing.
In most cases, when you get a loan from the dealership, you will end up sending your monthly payments to the bank or partner finance company, not the dealership where you bought the car. When you have repaid the loan, the financial institution will send you the title deed of the vehicle.
Set your target price and shop
Once you’ve done your due diligence on what exactly you can afford and have a pre-approval letter for a loan, you can now confidently research a range of vehicles within your target price range. . Fortunately, most of the first car purchases can be done online at home.
The Covid-19 pandemic and restrictions on businesses have forced many car dealerships to revamp and improve their websites, from simply listing inventory and generating leads to the entire process of selecting a vehicle, obtaining financing and closing the transaction.
This allows buyers to shop online from local dealerships for new or used cars without ever leaving their homes. There are also online aggregation websites like cars.com, cargurus.com, carfax.com, and others that help you find and often complete transactions. These searches also allow you to search nationwide, not just nearby, and dealerships will sometimes list freight costs if you buy the car online.
App-based companies like TrueCar, Carvana, and Vroom have digitized the process, including financing with multiple lenders and features like a seven-day test drive.
Buy from a dealer
Today’s auto buyer is tech-savvy, and so are dealerships. More and more car buyers come to dealerships with an exact car in mind because they have already visited the dealership’s website and scoured inventory to find the right vehicle.
In other words, consumers now have more choice and control, from budgeting to purchasing vehicles to finding the car of their dreams that also fits their personal financial profile.