Sure, we'd all like to drive around in a classic Porsche or a brand new BMW; but in reality, the automobile we drive is dictated by the new car loan amount we can afford. If your salary totals out at $30,000 per year, chances are you're not going to be parking a brand new Jaguar in your driveway anytime soon. Does that mean you're destined to drive a beat-up old Yugo around town? Probably not; but it's important to determine what monthly payment amount you can comfortably afford in order to determine what type of new car you should look at purchasing.
The first step in determining which new car you can afford is to figure out how much of a monthly payment you can handle. Just because a bank will approve you for a loan of $20,000 doesn't mean that's what's best for your budget. You typically want to keep your debt-to-income ratio at or below 35 percent. To figure out your debt-to-income ratio, you want to take the amount of your gross income and divide it by the amount of your monthly debt. When figuring your monthly debt, don't calculate your mortgage or rent payment. Only figure in things like your car loan, any credit card payments and revolving and installment loan payments. Then you're going to divide the amount of your monthly debt by your monthly gross income.
For example, if your gross monthly income was $2,500 per month and you had about $500 per month in debt obligations, your debt-to-income ratio would equal 20 percent. If you were to add a car payment of $300 per month to that equation, your debt-to-income ratio would be at 32 percent. If this were your scenario, you'd want to keep your new car loan payments at approximately $300 per month.
Once you figure out how much money you can afford each month for your car payment, you're going to need to figure out which cars fit into that price range. Just because you can stretch your car payments out over 7 years, doesn't mean you should do so. Typically, you should finance your vehicle for no longer than 5 years, with 3 years or less being the preferable term. To put it into perspective, look over the table below to see what type of car you could purchase while staying within your ideal payment range.
You'll notice that there are two different interest rate estimates. This is because not everyone qualifies for the same interest rates. When it comes to new car loans, the better your credit, the lower your interest rate will be. As you can see from the table, a lower credit score can make a big difference in your monthly payment amount.
| ||Monthly Payment |
|Type of car ||Car price ||5 yrs at 6% ||5 yrs at 17% ||3 yrs at 6% ||3 yrs at 17% |
|Compact economy ||$10,000 ||$193 ||$248 ||$304 ||$356 |
|Mid-size sedan ||$15,000 ||$289 ||$372 ||$456 ||$534 |
|Full-size sedan ||$25,000 ||$483 ||$621 ||$760 ||$891 |
|4WD SUV ||$33,000 ||$637 ||$820 ||$1,003 ||$1,176 |
|Luxury car ||$40,000 ||$773 ||$994 ||$1,216 ||$1,426 |
Of course the above is just an estimation of what your car payments could be, given the type of vehicle you purchase. The exact payments of the above new car loans would vary depending on your down payment, what options and extras you added to your vehicle, and your exact interest rate.
When using the above chart as a guideline, it's easy to see that not everyone will fit into the same new car loans. If you already have an unusually high debt-to-income ratio, you're going to want to keep your monthly payments as low as possible. In this case, the compact or economy car would be your best bet. Not only will you save money on your monthly car payment, but your insurance premiums will tend to cost less and economy cars generally use less gas, saving you additional dollars.
On the other hand, if you pull in a fat salary and a $1,000 per month payment on a new auto loan doesn't make you bat an eye, a more expensive car may be well within your reach. Just remember that it's important not to overextend yourself; being able to afford your new car loan is the primary objective.
Regardless of what new car category you find yourself shopping in. you'll be pleased to find out that there are attractive, high-quality cars in every price range.