It is not too often that you buy a car so when you do; you want the whole process to run as smooth as possible. This is the reason why it is very important to know first what you can afford because your responsibility as a car owner is not only limited when you are driving on the road but also on your monthly car loan payments.
Assuming you are applying for a car loan, like most of car buyers do, the rule of the thumb is simple: the amount of monthly mortgage should not exceed to 20% of your monthly income less tax. Anything higher would compromise other expenses and can definitely give you great financial stress. For example, if your monthly income less tax is $500, the maximum amount of car mortgage should not exceed $100. Now, you might say, “That’s okay, I can buy a car anytime.” Not too fast. Remember that your financial responsibility on owning a car is not limited to your monthly fee. Factors such as gas, maintenance, etc. which have monetary equivalent can eat a large chunk of your monthly budget significantly. Also consider your existing loans, monthly credit card bills, house mortgage, etc.
According to the US Census Bureau, the 2006 Median Annual Household income was $48,201. Which means, the average monthly household income in 2006 was $4000 after tax. Assuming that the MAD was the same for 2007 since changes can be minimal within a year, an average family can afford to pay as much as $700 or $800 a month for the car (if the family does not have any existing car loan). Not bad right? At this amount, the average household can own a vehicle worth $20,000 – $25,000 with 7.5% sales tax, 7.41% interest rate, 20% down payment at 36 months term. What is the monthly car mortgage an average household can afford? $543 to $679 (figures are for demonstration purposes and are rounded). You might ask, “Why is the monthly mortgage range from $543 to $679 and not $700 or $800?”
Again, gas, maintenance, insurance, etc should be included in the 20% car allocation. Now, you may afford a vehicle with higher value if you earn more than the median household annual income. But if your income is less than the figures given, opt for the vehicle with lower car value.
To further help you in identifying how much you can afford, follow this tips: (This is not limited to people who want to buy brand new cars since your monthly income can be from $1,000 to $10,000. You can use this when identifying how much you can afford for a used car.)
o Call or visit the insurance websites and get free insurance quote from your preferred insurance carrier. Ask for the estimate your insurance premium and ask for different options depending on the type of car you want to buy.
o Estimate your monthly mileage consumption and multiply it to the current gas price in your area.
o Consider the registration fee. Get the price you have to pay yearly for the registration.
o Estimate the maintenance cost of the car you want to buy. Maintenance cost usually shoots up for older cars. Also the more expensive the car is, the more expensive the replacement parts are. If you are buying a used car, ask for its service record and know how much is the annual or monthly maintenance cost.
The equivalent amount you have taken from these data should be subtracted to the 20% of your income. The difference should be a rough estimate of the car you can afford. So if 20% of you monthly income is, say, $600 minus the total estimate of your monthly maintenance, gas, insurance, etc which we assume to be at $100, the car mortgage you can afford is $400.
Finally, use free car mortgage calculator online. Now, different sites ask for different data but basically, your monthly income after tax, amount of down payment you can afford, loan duration, and interest rate are all they need. Car mortgage calculator is easy to use and you can get a pretty good idea of how much you can afford within seconds.