How Much Car Loan Could You Afford?

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January 27, 2012

Even if you're shopping for a used car, unless you have substantial savings that you're willing to part with in one fell swoop, you're going to need a car loan. One mistake some people make is that they aim too high when getting financing for a car, and because their income looks like it would be enough to cover that extra, large payment, they agree to it. But it's important to sit down before you decide which car you want and decide how big of a car loan you can really afford to pay back.

An Income Guideline for a Car Loan

The first step in deciding how much you can really afford is to figure out your monthly take home income (after taxes) and figure what 20% of that amount is. That's the magic number you don't want to go beyond with your car loan payment. If you make $2,000 a month, for instance, you don't want a payment that's more than $400 a month.

This 20% estimate is a good guideline as far as a maximum car loan payment, but you shouldn't necessarily go that high-just don't go above it. You have to look at all your other expenses and payments and take those in to consideration, too.

Total Monthly Income

A good rule of thumb is to make sure that your monthly income equals at least double your expenses. Unfortunately, not many families can hit this ratio today. But you should do everything you can to get as close as possible. If you make $2,000 a month, for instance, and all of your monthly expenses including food, mortgage, utilities, entertainment, transportation (gas, current car payment or bus fare) and anything you regularly spend money on equals $1,500 a month, you're in a precarious situation.

You're left with precious little reserves or money to save, and chances are that if you're living that close to your limit, the rest of the money ends up being spent each month, too. It's tempting to think that the "extra" $500 can cover your car payment of $400, but that's a recipe for disaster. One major repair or problem and you could have serious financial problems.

On a $2,000 a month income, car loan payments plus all other expenses shouldn't go above $1,000. If this isn't possible, then look at your other expenses and see where you can trim to get as close as possible. Reevaluate the type of car you want to buy, and consider a less expensive car.

Consider All Car Expenses

Don't forget, when you're trying to figure out the size of the car loan you can really afford, to factor in other costs. You'll need car insurance. If you've been paying only liability or you've been using other transportation, be prepared for the cost of full coverage insurance. Find out what it will be on the car you're looking at and figure that into your new cost. Also, if you can make a larger down payment, you can cut your monthly car loan payments and make a new car more affordable.

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