When shopping for a used car, a common question to ask yourself is, “What car loan can I afford?” It’s easy to let your eyes get big and see something that you love that’s really nice, but also really expensive. Anytime my wife and I get into a rental car, I make sure to tell her, “Don’t go falling in love with this, because there’s no way we can realistically afford it.” This is because I immediately go through a few simple rules in my mind.
A safe bet is to follow the 20/4/10 rule. This rule helps you to keep a realistic plan in mind when saving and shopping for your next car.
Save for a 20 percent down payment
Apply and budget for a four-year car loan
Budget for a monthly car loan payment and operating costs at 10 percent of your net monthly income
20% – Down Payment
Save 20 percent of the total cost of your new car, truck, or SUV for a down payment. Sometimes buying a new form of transportation is an emergency, so it’s tough to dig that much change out of the couch cushions. However, if you’ve been planning on buying a new car for a while, set 20 percent of the cost as a goal for your down payment. This not only helps reduce the cost of the vehicle by 20 percent but helps you to understand the true value of the vehicle you’re buying. So, if you want to buy a used Chevy Silverado that’s priced around $30,000, set $6,000 as your down payment goal.
4 – Term of Loan
Shoot to find a car that’s priced to fit your monthly budget with a car loan that has a 48-month term. As we know, it’s easy to spread the loan out over a longer term to lower the cost of the monthly payment. However, this only increases the amount of money you’ll pay in interest and skyrocket the end amount that you pay for the car. With a four-year loan as the ideal term for your loan, be sure to keep your monthly payment within the parameters you’ve set.
10% – Monthly Payment and Operating Costs
An easy way to budget your monthly car payment, try to keep your monthly payment and operating costs under 10 percent of your monthly net income. Don’t budget this off your gross income, because you’ll end up “car poor,” which is when your car payment is sucking up all your monthly funds and you’ll have a hard time meeting the financial demands that come with operating your car. For example, if you bring home $3,000 per month, you can afford a car with a monthly payment and operating cost of $300 monthly.
It’s important remember that there are other costs that come with owning and operating a car besides the monthly payment. You need to remember that you’ll have to insure your car, put gas in it, and change the oil every few months. Maintaining your car shouldn’t drain your savings account or consume your paycheck just to put gas in it. Keep in mind that high-end sports cars don’t run on fuel with an 89 octane rating or simple 10W-40 oil. If you’re in the market for a something like a used Cadillac Escalade, you’re going to need to put premium fuel and synthetic oil in your monthly budget.
Not sure if the car you have your eye on fits within your criteria? Take these rules with you when planning your monthly car payment. Use a car loan calculator to estimate your monthly payment. You can easily find a used car within your budget and still live a comfortable life.