How Much Should My Car Payment Be?

Buying a car can be stressful, not to mention one of the most expensive purchases many people will make in their lives. That’s why it’s so important to come up with a budget before shopping for a vehicle. You want to make sure you aren’t considering cars that are out of your price range and that you’ll struggle to pay for.

In general, it’s recommended to spend no more than 10% to 15% of your monthly take-home income on your car payment, and no more than 20% on your total vehicle expenses, including insurance and registration. Read on to learn how you can determine how much car you can afford based on your financial situation.

How to determine how much car you can afford

Before you start searching for your new car, you need to set a budget. Doing this will give you a better idea of the types of vehicles to look for. That might mean setting your sights on the most affordable sedan on the market, or considering a luxury SUV or crossover. The following steps can help you determine how much car you can afford.

Know your monthly post-tax income

You might know how much your annual salary is, but how does that translate to take-home pay? The easiest way to find out is to look at your most recent pay stubs, which will show you how much in taxes and other expenses (such as health insurance premiums or retirement contributions) are deducted from your monthly earnings. If your income varies from month to month, calculate the average amount over the last six months to a year and use that amount as your monthly take-home pay.

Calculate 10% to 15% of that amount

In general, your car payment shouldn’t exceed 10% to 15% of your monthly take-home pay. The following table shows a breakdown of ideal car payment ranges for a variety of monthly earnings.

Factor in additional car expenses

Your monthly car payment isn’t the only automotive expense you’ll need to budget for. In order to actually drive the car, you’ll need to insure it and fill it with fuel. 

• Car insurance is required in all states in order for you to legally drive your car. Each state differs in its rules, but you’ll need liability insurance at a minimum. If you want to be fully protected, adding collision and comprehensive coverage can help protect you financially if you’re involved in an accident or if your car is damaged by theft, vandalism, an animal encounter, or a hailstorm.
• Fuel prices fluctuate, whether you’re buying a gasoline or diesel car or going electric. Buying a fuel-efficient car can help keep your fuel expenses lower, but if gas prices hike suddenly you’ll have to shell out more money for the same amount of fuel. 

Other expenses to budget for include routine maintenance to keep your car running smoothly, as well as optional extras such as car washes.

Determine how much you can borrow

Just because your take-home pay allows you to finance a car doesn’t mean you’ll be approved for the amount you want to borrow. Lenders consider a variety of factors as part of the car loan application process, including the following.

• Your credit score.
• The loan term.
• The type of purchase.

Calculate your car purchase price range

If you plan on trading in your current vehicle as part of your new car purchase, you can factor it into your purchase price. There are several free online tools that allow you to value your trade-in, giving you a rough estimate of how much you can expect to get for your car. However, the actual amount you’re offered may be more or less than the estimate.

You can also look into private sales, which might result in a higher sale price for your existing car. Other options include used-car marketplaces such as CarMax and Carvana.

In addition to your trade-in, you might choose to put down a lump sum of cash as part of the purchase. The amount of your down payment will also factor into your budget for a new car. A higher down payment generally means you can afford to spend more on a car—or manage with a smaller monthly payment if you only need a basic vehicle.

Here’s an example budget based on the amount of the trade-in, the down payment, and the car loan.

Also consider that the vehicle list price likely won’t be the total amount you pay. The seller might have incentives in place that decrease the cost, or you might have to pay a premium for an in-demand vehicle model. You’ll also need to factor in sales tax and registration (both of which will vary based on your state). That $28,000 budget might mean a purchase price of $25,000, and tax and registration at a total of $3,000. That’s why it’s important to research these costs before you set a final budget.

Start shopping for a vehicle

Once you have your budget in place, it’s time to start looking for your new car. First, you’ll need to determine the type of vehicle that best suits your needs, and then look for options in your price range. For example, if you have a large family, you’ll probably need a three-row SUV or a minivan. If you are single or a couple and just need a commuter car, a small sedan or hatchback will probably fit the bill.

There are several options you can use to find a car. You can visit a dealership in person to see what they have on their lot and test-drive the models within your price range. If you already have an idea of the types of models that will work, you can search online at the dealership’s website or at a website like Edmunds or Kelley Blue Book that allows you to search for new or used vehicles in your price range. 

If you’re buying from a private seller, make sure you get a copy of the vehicle history report and have the car inspected by a mechanic you trust. This will help you avoid inadvertently purchasing a “lemon”—a vehicle that seems to be in good shape but actually has a bunch of problems that will cost you big down the road.

Options for financing a car

If you’re ready to apply for a car loan, there are several options available. Most buyers will get a loan from a financial institution or through their car dealership, but third-party loans may also be an option for those with poor credit.

Bank or credit union

Most banks and credit unions offer car loans, and many have a prequalification process that will help you determine how much you’re able to borrow. It’s a good idea to get prequalified for a car loan—either through your everyday financial institution or a different one that offers good rates—before you head to the seller to see and test-drive the car. 

Car dealership

Car dealerships have financing offices that specialize in finding car loans for customers. In some cases, the dealer may be able to offer you the lowest interest rate through one of its financing options. If you have prequalified for a loan at a bank or credit union, you can give that information to the finance officer, who can check to see if the dealership can find you a better deal.

Third-party loan

If your credit is less than desirable and you can’t find a car-loan lender that will approve your application, you can look into third-party loans. Even with bad credit, you will likely find a third-party lender that will approve you for a car loan. However, the interest rates on third-party loans can be high, which means higher monthly payments.

Consider your purchasing options

Although many drivers choose to buy their car, that’s not the only option. Leasing is a solid choice if you enjoy driving a new car every few years and aren’t concerned about equity—or if your company is paying for your car. Both buying and leasing have their advantages and disadvantages, which are described in more detail below.

Buying

Buying a new or used car has several advantages. Because you own the vehicle, you can modify it as you see fit. You can continue driving it for years, until it finally gives up, and there’s no annual mileage limit so you can take it on a cross-country road trip every year without worrying about extra fees. You can also sell or trade in your vehicle whenever you want and use the proceeds to help fund your next car purchase. If you keep the car and pay off your loan, you’ll have no car payment while you own the vehicle.

However, when you buy a car, you’ll have to deal with depreciation—especially with a new car, which Kelly Blue Book reports can lose 20% of its value within the first year, and 60% of its value in the first five years. You’ll also pay more up front when you buy a car, since you may have a down payment and you’ll need to factor in taxes and registration. And the interest rate on your loan payment will likely be higher than it would with a lease payment since you’re financing the vehicle’s full value.

Leasing

If you love the feel of driving a new car and want to switch vehicles every few years, leasing might be the best option. When you sign a lease, you’ll pay monthly to drive the vehicle during the lease term, which is typically two to three years. Once the lease has ended, you’ll return your car to the dealership and can sign a lease on a new car. Alternatively, you can purchase the car at the end of the lease. Monthly lease payments tend to be lower than car loan payments because you’re paying for the vehicle’s depreciation rather than its total value.

On the downside, leases have an annual cap on mileage, and if you go over that mileage (usually 10,000 to 12,000 miles) you’ll be stuck paying a hefty fee. Terminating your lease early will also result in additional fees. And if you make any modifications or the car shows more than the expected wear and tear upon returning, you’ll be charged extra.

TIME Stamp: Your car payment shouldn’t exceed 10% to 15% of your monthly take-home pay.

Buying a car that’s above your budget may seem doable, but if your monthly payments are more than 15% of your take-home pay, you may struggle to keep up with them. Failure to pay your car loan can result in your car being repossessed, and it can have a devastating effect on your credit score. By carefully calculating how much car you can afford before making a purchase, you can remain confident that your car payment will fit into your monthly budget without affecting any of your other expenses.

Frequently asked questions (FAQs)

How do lenders determine a car payment?

Your car payment will vary depending on the amount you borrow, the loan length, and the annual percentage rate (APR). A longer loan will result in lower monthly payments, though you’ll pay a lot more interest over the loan term. The lender will determine your APR by reviewing your credit history and score; a higher credit score results in a lower APR, and vice versa.

What can you do if a car payment doesn't fit your budget?

If a car payment doesn’t fit in your budget, the easiest thing to do is purchase a cheaper car. The higher the purchase price of a vehicle, the higher the monthly payments; therefore, if you go with a smaller or lower-cost vehicle, your payments will be lower. You may even be able to find a base trim of the model you want—you may miss out on certain features, but you’ll be better off financially.