icon of two gears to show concept of expanded lessons Expanded Lesson 5 min read

Calculating a Car Payment and Other Things to Know About Buying a Car

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So, you’re gearing up to buy a car and now it’s time to put your hard-earned money toward a beautiful vehicle that will hopefully last you for the foreseeable future. But calculating a car payment isn’t as straightforward as you might think. Getting pre-approved, locking in a low interest rate and shopping around for the best price is key to making sure you can afford your payments going forward. If you’re new to the world of buying a car, use this guide to get your finances in order before you sign on the dotted line.

Yellow notepad with pen svg icon Lesson Notes:
  • Establish a budget and use calculators to help determine an affordable monthly car payment. Use the 20/4/10 “rule” as a guide to see if the car payment is reasonable for your income.
  • Consider which auto loan term makes the most sense for your situation and be aware of the differences between getting pre-approved and using dealer financing.
  • Not everyone has the same needs or circumstances. Remember to factor in other costs like maintenance, gas and insurance and make sure your monthly payment is within your budget.

Find Out How Much You Can Afford

It’s always best to come up with a budget before you hit your local dealership or start shopping for cars online. Knowing how much you can spend will help you limit your search to vehicles in your price range. This will also help you keep your expectations in check when comparing different makes and models.

To calculate a car payment, you first need to calculate your monthly income. If you work freelance or your income tends to vary from month to month, average your income over the last 12 months to get a sense of how much you will make down the line.

The 20/4/10 rule of thumb can be used to help determine if a car is affordable. The rule states that you should make a 20% down payment and not finance the car for more than four years. After that, your monthly payments shouldn’t exceed more than 10% of your monthly expenses.

The larger your down payment, the less your monthly payment will be and the faster you’ll be able to pay off the loan. While a 20% down payment is a good target, not everyone may be able to pay that upfront. If you can’t afford a down payment, consider waiting to purchase the car until you have enough saved if you don’t need a new vehicle right away. If you have more urgent needs, you can consider looking at cheaper vehicles or lowering the down payment amount. Keep in mind that if you have a lower down payment, your monthly loan payment may be higher. Always make sure your monthly payment will be something that fits your budget and doesn’t affect your ability to pay for necessities or other bills.

As for your 10% monthly car payment, make a list of all your car-related expenses, including:

  • Car Payment.
  • Gas.
  • Maintenance/Repairs.
  • Insurance premiums.
  • Warranty fees, including the deductible and monthly payment.
  • Vehicle registration.

If the total monthly car expenses are more than 10% of your income, you may want to look at ways to cut back and save money. Shopping around when you renew your auto insurance can help you find better rates for your coverage. Paying your premiums on an annual basis also may be less expensive than paying monthly. Don’t be tempted to purchase a car that’s too expensive. Even if you think you’ll be able to afford the monthly loan payment, you still want to have enough money set aside for maintenance, repairs, insurance and other expenses.

Use the calculator below to figure out how much you can spend on a car based on your current finances.

Taking Out a Car Loan

Once you have some estimates in place, you will need to look for an auto loan. Compare the terms and conditions of different loans before signing. Credit unions tend to offer more competitive rates than banks, so consider reaching out to your local credit union. Many have representatives who can help you to understand your budget and what payment you can afford.

One important factor when choosing an auto loan is the term of the loan. Different lenders have different term options which can vary depending on the age of the vehicle. Typical terms range from 48 up to 84 months. Interest rates on the different terms vary as well. Typically, the longer the terms, the higher the interest rate is. With a longer-term loan, you may have a smaller monthly payment, but the amount of interest that accrues over the life of the term will be greater. The quicker you pay off the vehicle, the less interest you will pay. Be sure to factor in the length of the term as well as in the interest rate when considering an auto loan.

You can apply for a loan in a :

  • On one hand, you can apply for financing at the dealership once you’ve picked the vehicle you want. While you may be able to negotiate some points of the loan, the dealer may not have as competitive interest rates as getting the loan directly from your credit union or bank.
  • The dealer can also forward your collected information to prospective auto lenders. If the lender(s) chooses to finance your loan, they may authorize or quote an interest rate to the dealer to finance the loan.
  • You can also get pre-approved for an auto loan at a financial institution before you start shopping. This helps you lock in exactly how much you can afford, which can be an asset during the negotiation process. You won’t be tempted to buy a car that’s out of your price range.

The calculator below can give you an idea of the monthly payment of the auto loan.

Exceptions to the Rule

It’s important to remember that the 20/4/10 rule isn’t for everyone.

Many people will save up until they have enough money to buy a car outright in cash. This helps you avoid having to take out a loan in the first place, which means no debt and zero interest.

However, this isn’t realistic for many consumers. If you need a car now, be thorough in your search for an affordable vehicle. Use websites, apps and local dealership listings to expand your range of options. Taking a few thousand dollars off the asking price could make all the difference in the world when it comes to paying off the car.

Many of these estimates are likely to change as time goes on. Again, pad your budget to make sure you can keep up with your car payment over time. Your monthly expenses will vary greatly based on insurance, your driving history, where you live and how often you use the car. You might not have to set aside as much for a warranty or gas if you seldom plan on using the car. 

Use this information to find a car that works with your budget. With a little research and planning, you’ll be driving your new ride before you know it!

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