How to determine how much you can afford to spend on a new car
This story is part of the CNBC Make It’s One-Minute Money Hacks series, which provides simple, straightforward tips and tricks to help you understand your finances and take control of your money.
Planning to buy a new or new car for you is an important decision. And before you sign on the dotted line, it’s important to understand how much it will really cost you.
When browsing your options, keep in mind that financial experts will usually tell you to spend less than 10% of your monthly take-home pay on your car payment. This means that if your take home pay is $ 3,000 per month, plan on spending no more than $ 300 on your car payment.
Then do some research to determine the interest rate you are likely to qualify for. Much depends on your credit score so it is different for each person. But generally, the higher your credit rating, the lower the interest rate you will get.
If you are buying a new car, the average interest rate for someone with a credit score between 661 and 780, which is considered in the “ good ” range, is 4.71%, according to Bankrate. The average interest rate for someone with a credit score between 501 and 600, which is considered poor to fair, is 11.33% – a major difference.
And keep in mind that while used cars are generally cheaper, used vehicle interest rates tend to be higher. When buying second-hand, the average interest rate for someone with a credit score between 661 and 780 is 6.05%, according to Bankrate. For someone with a credit score between 501 and 600, that’s 17.78%.
From there, you will need to decide on the length or duration of your auto loan. In the second quarter of 2020, the average term for a new car loan is approximately 72 months, or six years. Auto loans have grown in recent years, with 72- and 84-month loans replacing more traditional 48- and 60-month loans. Experian Reports.
The more time you spend paying off the loan, the more interest you will end up paying. It can explode your budget, even if a longer loan reduces your monthly payment.
Here’s an example: let’s say you want to buy a car for $ 30,000 (the average price of a new car is approximately $ 40,000) with 5% APR and no down payment. If you take out a 60 month loan, that works out to a payment of $ 500 per month. But remember, you have to pay that 5% interest as well, so your monthly payment is actually around $ 566.
Over 60 months, or five years, you will end up paying a total of about $ 34,000.
That’s a pretty heavy monthly payment. Suppose you extend the loan to 84 months, or seven years, which brings the monthly payment down to around $ 360 per month. With continuing interest, you would actually pay around $ 424 per month and spend over $ 2,000 more for a total of around $ 36,118.
And remember that the monthly payment isn’t everything. You should also budget for insurance, gasoline, maintenance and other expenses, which should not cost more than 5% to 10% of your take-home pay.
You need to consider all of these factors together when calculating how much you will actually spend on your car each month.
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More from this series: This Simple Money Hack Could Help You Increase Your Retirement Savings By $ 20,000 Or More