Driving is expensive: from buying the vehicle to covering the cost of gas and maintenance. Owning a vehicle takes a significant chunk of your personal finances. So, a key question to ask yourself is this: “How much car can I afford?” If you’re a regular driver and are thinking of buying, leasing, or financing a car sometime soon, this is a question you need to ask yourself before making any big decisions.
Key Points
- The amount you can afford on a car purchase depends on your income and current debt load.
- You should crunch the numbers to see what you can realistically afford before buying a car.
- Don’t forget to account for all expenses besides the purchase price, such as warranty, insurance, gas, and repairs.
How Much Car Can I Afford?
The cost of buying and financing a car involves more than just the ticket price. In addition to your loan payments, the total cost will also include maintenance and operating costs, such as the following:
- Insurance
- Gas
- Repairs
- Maintenance
To help you get a clear understanding of how much car you can afford, you’ll need to look at both the cost of buying a car and all your current financial obligations.
You should have plenty of money left over after all your current bills are paid to comfortably cover car payments. If not, you may need to reexamine car budget, and whether you can afford one at all.
How To Calculate How Much Car You Can Afford
There are a couple of methods you can use to calculate how much you can afford in a car purchase:
- 20/4/10 Rule
- 10% to 15% Rule
How Much Can I Afford Using The 20/4/10 Rule?
When it comes to financing new or slightly used cars, some vehicle experts recommend that drivers stick to the 20/4/10 rule. This is a basic calculation you can follow to make sure you choose a vehicle you can afford.
The Down Payment (20%)
The down payment that you’ll need to make on any car that you’re looking to finance should be at least 20% or more. If you decide to put less than 20% as a down payment, you’ll likely fall victim to the depreciation of the vehicle and end up spending more on loan payments than the car is actually worth. Plus, a higher down payment means less money to borrow, which can translate to lower monthly payments.
The Loan Term (4 Years)
While there are many loan term lengths to choose from, it’s recommended to pay off your car loan in no more than 4 years. A term any longer will start to make the car payments unaffordable and will have a greater impact on your finances in the long run.
While a 3-year financing period is an even better choice, know that the more years you add on to your payment period, the more you’ll pay in interest.
The Percentage Of Your Income (10%)
Ideally, you should be spending no more than 10% of your net income on your car payments, which include the principal, interest, and insurance fees. Depending on your financial and living situation, spending more than 10% of your net income could drain your chequing account very quickly. This is money that you could be putting in other places, such as your TFSA or RRSP.
| Example: Calculating Affordability Using The 20/4/10 Rule Let’s assume the following in this example: – Car loan term: 48 months – Monthly net income: $4,000 – Maximum you should spend per month on a car: $400 ($4,000 x 10%) – Other car related expenses: $200/month – Amount left over for car payments: $200 – Maximum car loan you can finance: $9,600 ($200 x 48 months) |
While this is the total amount you can finance in this example, the car you can afford can increase by the down payment you’re able to make. For example, if you’re able to make a $1,000 down payment, you’d be able to afford a car price worth $10,600.
With this information, you can then compare car financing offers for the loan amount required.
How Much Car Can I Afford Through the 10% To 15% Rule?
Another strategy for determining how much you can afford in car payments is by using the 10% to 15% rule. Using this strategy, your car payments should be no more than 10% to 15% of your gross annual income based on this budgeting strategy.
Using gross income provides a broader idea of what you can afford, but it’s also a good idea to consider your net income to make sure you’re not stretching your budget too thin.
| Example: Calculating Affordability Using The 10% To 15% Rule Let’s assume the following in this example: – Annual income: $48,000 – Maximum annual car payment amount: $4,800 (10% of income) to $7,200 (15% of income) – Monthly maximum car loan budget: $400 to $600 |
Based on how you calculate car affordability in the example above, let’s look at what you should be budgeting for based on various other annual incomes:
| Annual Income | 10% | 15% | Monthly Car Budget |
| $20,000 | $2,000 | $3,000 | $167 – $250 |
| $50,000 | $5,000 | $7,500 | $417 – $625 |
| $70,000 | $7,000 | $10,500 | $583 – $875 |
| $90,000 | $9,000 | $13,500 | $750 – $1,125 |
| $100,000 | $10,000 | $15,000 | $833 – $1,250 |
Using the above chart, you can see how much you can afford in monthly payments based on different annual incomes. So, if you earn $50,000 per year, for instance, you shouldn’t spend any more than $417 to $625 per month. If you’re a higher earner and bring home $100,000 every year, you can bump up your car expenses to $833 to $1,250 per month.
| Be Aware: Most auto dealers now offer loan terms as long as 84 months or more, which reduce your monthly payments. But this might make you think you can afford a more expensive car over the long term, when that may not necessarily be true. Crunching the numbers based on your income and current debt levels is essential. |
Other Car Expenses To Consider
In addition to the purchase price of your vehicle, there are various other expenses to factor into your budget, including the following:
Warranty
New vehicles generally come with a basic factory warranty. Coverage includes nearly everything on the vehicle, with the exception of wear and tear. But if you want an extended warranty, you’ll need to pay for it.
The cost of an extended car warranty in Canada can vary widely depending on many factors, such as the car’s make and model, the level of coverage, and the warranty provider. On average, however, prices range from $1,000 to $3,000 for a plan that lasts several years.
Insurance
In Canada, car insurance is mandatory to legally drive on the road. The cost of car insurance varies depending on several factors, including your location, age, driving history, vehicle type, and coverage amount. On average, however, you could be looking at roughly $1,000 to $2,000 per year for car insurance, though it may be lower or higher.
Fuel
Gas is pretty pricey these days, which can eat up a big chunk of your finances every month. Estimate roughly how far you drive every month and how often you have to fill the gas tank to get an idea of how much you can expect to pay to fuel up each month.
Repair And Maintenance
Cars need regular maintenance to keep them running smoothly and safely. That includes paying for services like oil changes, car washes, tire rotations, and so forth. And every so often, you may have to cover the cost of unforeseen issues, such as bodywork for dents or fender benders.
How To Calculate The Highest Car Price You Can Afford
To determine how much you can afford for a car with great accuracy, follow these steps:
Step 1: Figure Out How Much You Can Afford Monthly
When calculating how much you can afford for a car, the most obvious step is to base your affordability on your income. But it’s your take-home pay — or “net ” pay — that you should consider, and not your pre-tax income — or “gross” income. This will give you a more accurate idea of how much money you can afford to spend.
Once you know what your net monthly take-home pay is, you can use any one of the above-mentioned tactics to come up with an accurate idea of your maximum monthly car payments based on your current finances. But again, a long loan term can look affordable because of the stretched-out repayments, when the loan may not necessarily be affordable for you. If possible, try to keep your loan term to no longer tan 5 years.
Step 2: Determine How Much You Can Borrow
Once you’ve calculated the monthly car payment amount that best fits into your budget, you’ll have a better idea of how much you can borrow. This will depend on several factors besides your income, such as the following:
- Credit Score. The higher your credit score, the more likely you’ll be offered lower interest rates.
- Loan Term. A longer-term means lower monthly payments, though this also means more interest paid overall.
- Current Debt Load. A high income may give you more money to work with when taking out a car loan, but your current debts should be manageable before adding another payment to the mix.
- Whether You’re Buying New Or Used. New car loans typically come with lower interest rates compared to used car loans.
Step 3: Calculate The Vehicle’s Price
The total cost of buying a car doesn’t end at the ticket price of the vehicle, as mentioned. Be sure to factor in sales tax, registration fees, documentation fees, and other expenses, which your car lender and dealer will lay out for you.
| Here’s an example for illustrative purposes: The following is an example of what your total vehicle cost would be on a car with a $40,000 ticket price: – MSRP: $40,000 – Dealer fees: $1,000 – Pre-Delivery Inspection (PDI) & Freight: $1,800 – Sales Tax (13% HST): $5,564 – Total Cost: $48,364 In this case, your new car would cost you $48,364 to buy (if you were buying in cash; getting a loan will cost you more due to interest). But there are also regular costs you’ll need to pay going forward, including insurance, gas, and maintenance. The following are rough estimates based on 20,000 km driven per year: This adds up to about $5,000 per year ($416/month) in ongoing cost, which you’ll need to budget for. |
What Affects Your Car Loan Borrowing Power?
When you apply for a car loan, your lender will assess several factors to determine your borrowing power, including the following:
- Your Income Relative To Your Debt: Lenders look at your net income after all your existing expenses have been covered to see what’s left over and available for car loan payments.
- Employment Stability: A steady job assures lenders that your income is consistent enough to make loan payments.
- Credit Score: Your credit score is an indication of your creditworthiness. So, a higher score increases your chances of getting approved for a loan with more favourable terms and lower rates.
- Loan Terms: The monthly amount you’ll pay and your overall borrowing power is based largely on the loan amount, interest rate, and loan term.
- Down Payment: The bigger the down payment, the less you’ll need to borrow, which may increase your purchasing power.
- Vehicle: The age and value of the vehicle you’re buying can impact the loan terms and interest rates.
How To Increase Your Car Buying Power
To maximize the car loan amount you may qualify for, consider these tips:
Keep Your Spending In Check
Come up with a budget to help you keep tabs on your spending. This will help you create less debt while putting more into savings. You can then apply those savings toward a car purchase, which can then help you qualify for a more expensive car.
Buy A Cheaper Car
All cars serve the same purpose; namely, they get you from point A to B. Functionally, a car that costs $80,000 does the same job as one that costs $40,000, for example. Used cars can be much more affordable while still giving you the transportation you need.
Cut Down On Debt
If your debt is a bit out of control, consider hunkering down to pay off as much as you can before buying a car and applying for an auto loan. A lower debt level will show lenders that your debt is under control and that there’s enough income left to cover your car loan payments. The lower your debt, the more income you’ll have left to put towards your car.
Several debt repayment strategies can be used, like the snowball or avalanche method:
- The Snowball Method: This is a debt repayment strategy that focuses on paying off your smallest debts first, regardless of the interest rate.
- The Avalanche Method: This strategy targets high-interest debt first, which helps minimize the total amount of interest you pay over time.
Comparison Shop
Don’t apply for a car loan with the first lender you come across. While that may be the one you end up working with, you should still see what else is out there.
You can use an online loan aggregator to compare different car lenders and loan offers. Moreover, many lenders offer pre-approvals, which can show you the loan amount you may secure based on your current financial and credit profile.
Use A Cosigner
You can minimize the risk for the lender by adding a cosigner to your car loan contract. This will not only boost your odds of loan approval, but you may also secure better terms, a lower rate, and a higher loan amount.
Be sure that you and the cosigner understand the potential risks of this tactic, as the cosigner will be responsible for the loan if you default.
Bottom Line
In many cases, having a car is a must, especially if you rely on it to get you to and from work. But it comes with a hefty price. No matter what type of vehicle you’re looking to buy, make sure you can afford not only the car loan payments but all other regular costs that come with car ownership.
