With so many various colors and options available, thousands of Americans flock to local car dealerships daily searching for their next car.
Many of these new car owners will use financing in order to get their next auto loan. If you are in need of a car and are looking to finance a purchase, you might be wondering how much you should spend on a new car.
How Much Should I Spend on a Car?
Most experts agree that consumers should never use more than 15% of their pre-tax income towards car-related expenses. This includes the car loan payment, insurance, gasoline, and other related expenses.
Lenders will calculate your PMI, or your Payment-to-Income ratio, to see how much they will loan you. Ideally, most lenders like to see a PMI of .15. But how do you find your PMI?
First, find your pre-tax monthly income. For simplicity, let us assume that your income is $4,000 per month, pre-tax. A lender will take that $4,000 multiply it by .15 to find out how much your monthly car expenses can be.
Multiplying the $4,000 by .15 gives us $600 per month in car related expenses. This means that your auto loan payments, insurance expense, gas expense, and other car-related expenses should not exceed the $800 per month we calculated above.
If a lender sees that you can afford $600 per month in car-related expenses, they may only qualify you for a $300 per month auto loan, with the remaining $300 going towards gas, insurance, and other expenses.
The 20/4/10 Rule Explained
If you are financing a car, you may have heard about the 20/4/10 rule. Although lending standards will vary based on your income, location, credit, and lender, it’s a good start.
The rule states that consumers should:
- Provide a down payment of 20% of the final vehicle selling price
- Finance the car for a period no longer than 4 years or 48 months
- Allocate 10% of your pre-tax monthly income towards an auto loan
Although the rule advocates for only 10% of your pre-tax monthly income going towards an auto loan, lower-income consumers may not be able to find any car if they use the 10% rule.
If you are looking to buy a new car but have less than perfect credit, CrediReady can help. Our nationwide network of trusted dealers and verified lenders work with buyers in all credit situations.
Take a moment to fill out our free no-obligation loan inquiry form and start shopping for your dream car today!