Cars are a necessary expense for most Canadians. This is why it’s important to account for all factors before purchasing a car, including the price of the car, insurance, gas and repairs, loan payments, and more. Let’s take a look at some key considerations and tips to help you budget for your next car.
Key Points
- Consider all costs involved with buying, financing, and owning a car before making a purchase.
- Set a budget to determine how much of your income can be dedicated toward making car loan payments.
- Shop around with lenders and compare quotes to ensure you’re getting the best deal on a car loan.
How Much Should You Spend On A Car?
Canadians spend an average of $66,550 on new cars, and about $35,754 on used vehicles. That said, this doesn’t necessarily mean you should spend this amount. The price you pay for a car depends on the following factors:
- Your income
- Your current debt level
- The type of vehicle you want/need
To get an idea of how much you can spend on a car based on your specific financial situation, consider using the 20/40/10 rule or Total Debt Ratio (TDS), which we’ll explain below.
How To Budget For A Car?
Not everyone has the same financial or transportation scenario. That being said, not everyone will have the same approach to budgeting for a car. Depending on your income and frequency of use, you may decide to spend more or less on your car budget.
Regardless, here are a couple of common approaches to when budgeting for a car.
Car Budget Method #1: The 20/4/10 Rule
One common car budget rule is the 20/4/10 rule, which represents the following:
- 20% Down Payment: Make at least a 20% down payment upfront. This reduces the loan amount you’ll need and helps avoid the risk of becoming ‘upside down’ on your car loan as it depreciates.
- 4-Year Loan Term: Keep the loan term to no longer than 4 years to keep interest costs as low as possible and repay the loan sooner than later.
- 10% Of Your Monthly Income: Your car payments should not exceed 10% of your monthly income to help you maintain your budget without spending too much on your car.
Car Budget Method #2: Total Debt Ratio
Consumer experts say that one shouldn’t spend more than 36% of their income on debt. This includes monthly payments on credit cards, student loans, mortgages, and more.
Find out how much of your income every month goes toward your debt, otherwise known as your debt-to-income ratio. This is calculated by dividing your monthly debt by your before-tax monthly income. Then, you can see if there’s any room to add to it with a car loan payment.
| Example: Monthly car loan payment: $400 Other monthly debts: $600 Total monthly debt payments: $1,000 ($400 + $600) Gross Monthly Income: $5,000 Debt-To-Income Ratio: 20% ($1,000 ÷ $5,000) In this example, your DTI ratio would be 20%, which is well below the maximum threshold that lenders typically prefer. |
Learn more: How Much Car Can I Realistically Afford?
What Can Affect Your Car Budget?
The total cost of a car doesn’t just include the ticket price. There are other costs to factor in that will affect the total amount you spend on a vehicle purchase, including the following:
- Car loan payment
- Borrowing costs (ie. interest rate and loan fees)
- Car insurance
- Sales tax
For instance, if you want to keep your car expenditure to no more than $20,000, that doesn’t mean you look at cars that are priced at $20,000. Instead, you’ll need to buy a car that’s well under this threshold to accommodate the above-mentioned costs, which can add up to thousands of extra dollars on top of the car’s ticket price.
How Much Can You Afford If You Consider The Term?
Having a monthly budget in mind is a good start, but you should also consider ow much you want to spend in total. A monthly budget of $400, for example, would be $19,200 over 4 years, but over a 7-year term, the total would come to $33,600. While that $400 per month may fit well within your budget, you should also ask yourself if you’re willing to spend that much on a vehicle purchase.
To help you understand how much you can realistically pay for a vehicle, let’s illustrate using an example.
| Let’s say you live in Ontario and have $500 a month available for your car, and you only want to spend $20,000 in total. Given this, how much car can you actually afford? In this example, you need to consider the following extra costs: Insurance premiums: $1,528/year (in Ontario) Interest cost & fees: 7% average interest rate over 4 years (recommended term) Sales tax: 13% (in Ontario) of the car price Down payment: Ideally, you should pay anywhere from 10% to 20% of the car’s price upfront. You’ll want to consider all the expenses if you want to stay within your $20,000 limit. |
Car Insurance
In Canada, auto insurance is legally required to drive a car. Plus, if you’re financing your car, your lender may also want proof of insurance before they extend you a loan.
The cost of car insurance varies based on your location, car model, driving record, and mileage per year, among other things. That said, insurance premiums can cost around $1528 for drivers in Ontario on average. This can take a big chunk out of your monthly income, so be sure to budget accordingly.
Cost Of Financing A Vehicle Purchase
If you’re taking out a car loan to buy a vehicle, you’ll need to factor in costs that are specific to financing:
- Interest: Lenders charge interest on the loan amount, which is the cost of borrowing money. The rate you’re charged depends on your credit score, down payment, and lender’s terms. The lower the rate, the more affordable your loan will be, and vice versa.
- Loan Origination Fees: These are fees that lenders charge for processing the loan.
- Documentation Fees: These are costs related to preparing and managing the paperwork associated with processing the loan.
- Prepayment Penalties: If you pay off your loan early, you may be charged a prepayment penalty fee, depending on the lender.
Sales Tax
In most cases, you’ll need to pay sales tax on your vehicle purchase. However, the amount you pay for sales tax depends on what province you buy the car in, whether you’re buying new or used, and whether you purchase from a dealership or a private seller.
For instance, in Quebec, you’ll need to pay 14.975% sales tax on a new car or a used vehicle from a dealership. However, if you buy a used car from a private seller, only the 9.975% provincial sales tax rate applies.
Learn more: Taxes On Cars In Canada: Dealership vs. Private Sale
Down Payment
The down payment will often require you to use money out of pocket, as lenders will want to see that you can put some money down toward your car. Although some lenders will finance your purchases with less than 20% down, it’s ideal to make a 20% down payment on a car. The higher your down payment, the lower your monthly payments will be, and the more likely a lender will be to finance your purchase.
Learn more: How Much Should A Down Payment For A Car Be?
Other Expenses To Consider When Budgeting For A Car
When buying a car, you aren’t only paying for the amount listed on the price tag. There are other expenses to consider when buying a car, such as the following.
Title And Registration Fees
These fees cover the cost of registering the vehicle with your local government office and obtaining a title. You can pay anywhere from $50 to $300 for these fees.
Extended Warranty
An extended warranty is optional coverage that takes effect after the manufacturer’s warranty ends. It helps cover the cost of specific repairs or services for a certain amount of time or mileage limit that may not be covered with a standard warranty. Keep in mind that this is not a requirement, but may be something you should budget for if you choose to buy it.
Fuel
You will need to budget for the cost of gas when driving your new car. Depending on the model, you may need to spend more or less on your gas budget.
If the car is good on gas, you may be able to save a bit of money here. However, some models use up a lot of gas, which in turn requires you to have a higher gas budget.
Repairs And Maintenance
Experts say that you should budget at least $2,000 on car repairs every year. However, this is a general number. Depending on your car model, repairs and maintenance can be more expensive.
You’ll want to be on top of maintenance visits and ensuring your car is running smoothly. Additionally, you’ll want to be prepared for any possible accidents or issues that could result in your car needing repairs.
How To Save And Budget For A Car
Consider the following tips to save and budget for a vehicle purchase:
- Set A Savings Goal – Figure out how much you’ll need to cover the down payment, sales tax, and fees when buying a car. Then, break down this figure into smaller monthly savings targets.
- Automate Your Savings – Have a set amount or certain percentage of your deposits automatically transferred to your dedicated savings account. That way, you don’t have to manually do this, and have no excuse for forgetting to set money aside for a future vehicle purchase.
- Use A Budgeting App – Many budgeting apps can help you track your budget in real time and get easy-to-use snapshots of where your finances stand at any given time.
How To Keep Car Costs Low
Even after you’ve purchased your vehicle, there are several ways to cut the cost of your car and keep more money in your pocket. Here are a few ways to minimize costs associated with car ownership and operation:
Regularly Maintain Your Car
Keep up with oil changes, changing air filters, tire rotations, and other routine services to avoid costly repairs. Keep a regular schedule and stick to it, and find a good and honest mechanic who won’t inflate their prices.
Make Small Repairs Yourself
If you’re up for it, consider taking on minor DIY repairs on your own, such as replacing wiper blades or changing air filters.
Drive Efficiently
Avoid accelerating too quickly, driving too fast, and aggressively braking to improve fuel efficiency. All these actions can cost more in gas, so be mindful of these behaviours and drive more efficiently.
Check Your Tires
Underinflated tires can use up more gas to run your car, making it less fuel efficient. Check your tire pressure on a regular basis and keep them properly inflated to reduce fuel costs.
Shop Around for Insurance
Compare insurance companies and their offerings every year to make sure you’re still getting the best possible rate. You can also use certain tricks like bundling your insurance and increasing your deductibles to lower your car insurance costs.
Learn more: How to Save Money on Your Car Insurance
Consider Carpooling
Depending on your route to work and where your co-workers or other acquaintances live and work, consider carpooling to spread the cost of gas and wear and tear with others. Consider doing the same in other areas, such as driving the kids to school or to recreational activities.
Shop Around For Different Car Loans
If you’re financing your vehicle purchase, make sure to do some comparison shopping first to see where the best deal lies. You can do this quickly and easily using an online loan platform like Loans Canada.
What Happens If You Buy A Car Out Of Budget?
Buying a car beyond your budget can lead to the following:
- Financial Strain: Higher loan payments can make budgeting more difficult.
- Debt Accumulation: Taking out a car that’s too much for you to handle can lead to missed payments.
- Insurance And Maintenance Costs: More expensive vehicles typically come with higher insurance premiums and maintenance/repair costs.
- Possible Repossession: If you miss too many car loan payments, your lender may repossess the vehicle, leaving you without a car and a damaged credit score.
Bottom Line
Budgeting and saving up for a car is all about planning ahead and making careful and well-informed decisions. By understanding all costs involved, setting attainable goals, and remaining disciplined, you can ensure that your purchase is a financially responsible one.
