Car shopping is a whole lot easier when you know what's in and out of your price range.
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Car shopping is one of those experiences that's both exciting and stressful. It's a lot of fun to test drive different cars and eventually get a new ride, but then there's also negotiating with car dealers and deciding whether a car is really in your budget.
Before you hit the road to look at new cars, it's imperative that you decide how much you can spend. By taking a little time to do that, you'll know exactly what cars you can look at, saving you time and making your buying process much smoother.
How much should you spend on a car?
As a rule of thumb, it's a good idea to limit your car payments to between 10% and 15% of your take-home pay. If you take home $4,000 per month, you'd want your car payment to be no more than $400 to $600.
There's a caveat to this rule, though. You shouldn't get a longer loan term than necessary just to lower your monthly payment, because that will ultimately cost you more in interest. The longest auto loan you should get is:
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60 months if you're buying a new car
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48 months if you're buying a used car
The reason why you don't want to get an auto loan for longer than those terms -- besides the extra interest you'll pay -- is that you'll run a greater risk of becoming "upside-down" on your loan, i.e., owing more on the car than the car itself is worth. With how quickly cars depreciate, lengthy loan terms are almost never a smart move financially.
What about the total purchase price of the car? The most prudent approach is to buy a car that costs no more than 10% to 20% of your annual income. Many consumers exceed that recommendation, but it's best not to tie up too much of your money in a vehicle.
Customizing your car budget
Although 10% to 15% of your take-home pay works well as a general guideline for buying a car, you also need to take into account your current spending habits.
Ideally, after factoring in your car payment, you should still be able to:
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Pay for all the necessities
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Save 10% to 20% of your income
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Have disposable income remaining for non-essential expenses
Look over your budget to see how much you're spending and saving each month. This will give you the most accurate idea of how much you can spend on a car.
For example, if you've been saving 30% or more of your income, then you have the flexibility to spend more on a car. On the other hand, if you aren't able to save much money, then putting 10% to 15% of your income toward a car payment may be far too much.