Deciding on the perfect car for yourself is hard. Negotiating a good price for it is even harder. But hardest of all is securing affordable financing for your purchase.
Car subscription series may be on the rise. But there nowhere near being affordable yet.
Which means your best strategy for success, as many experts have repeatedly emphasised, is setting up a budget and then sticking to it. In this feature, we’ll show you how to do that. We’ll use specific numbers as an example so you can get to work straight away.
One of the tools which will certainly help you arrive at a great decision is our free online car loan calculator. Use it to find the combination of interest rate, loan duration and down payment that’s best for you.
Setting the budget: Overview
At the end of this article, we’ll provide you with a step by step guide to setting your budget for buying a car. Before we get there, however, here’s a brief overview of the idea behind the approach.
The strategy consists of two steps.
First, you need to calculate the total cost of buying the car. Perhaps you can not yet set this exactly at this stage. But you can at least make an informed estimate.
Secondly, you will need to verify how much you can spend on paying off the loan each month. This depends on a variety of factors. You will need to crunch some numbers here, so keep a calculator at hand.
Once you’ve done the maths, you can now see whether what you need can be paid off by what you have.
Sounds like a plan? Then let’s get started.
Total cost of buying a car
This almost sounds like a trick question. After all: Doesn’t it tell you the price of a car right in the ad?
It does indeed. But that’s not the total price of a car. In fact, it’s not the total price by a long shot. Instead, we call this the ‘sticker price’. To arrive at the amount you’ll actually need to meet with your budget, we have to dig a little deeper.
To arrive at the total cost, you’ll need to add …
- … the sales tax
- … registration fees
- … extended warranties
When you’re buying a car on finance – which you most likely will – you’ll also need to add the interest paid on the loan. In some cases, this can be as much as the actual value of the car.
And … that’s still not all!
Needless to say, the running costs of a car can not be ignored either. These include:
- Road tax
- Everything that keeps the car in good condition
Only after you’ve added all of this up can you take the next step: Looking at how much you can spend.
Budget for buying a car #1: What’s your income situation?
If your credit rating isn’t particularly great, you’ll probably worry most about your debt situation. But believe us when we say: The most important part of setting up a budget for buying a car is your income.
Even if you’re not earning a lot, your income will decide how much you can spend. Unless you can easily switch from your current position to a better paying one or ask for a raise, it is the one component of a budget that you can not actively change.
Unfortunately, it is also the number that most lenders will look at first. Usually even before checking your credit score. This means you’ll have to search even harder for alternatives to improving your budget.
From your monthly income, subtract your fixed costs, such as rent or mortgage, heating and everything else related to your housing situation. Finally, subtract average spendings on food and other essentials. The remainder of these calculations is your disposable income.
Budget for buying a car #2: How much is your trade-in worth?
Let’s continue with what you have. Typically, you can trade in your old car when committing to buying a new one. This does not need to happen at the dealership where you’re getting your car. But it does make sense, as it can significantly improve the overall conditions of the deal.
You can add the value of the trade-in to your assets. So how do you set a realistic number here?
Certainly, the price you can find at a site like parkers is not what you can expect to get from a dealer. It is possible in theory, but most dealers will be able to bring that number down quite a bit.
Instead, leave a little wiggle room and subtract something like 30-40% off the online estimation. This should still give you quite a bit of funds to help you finance the car you want.
Budget for buying a car #3: What’s your debt situation?
Let’s now move towards the dark side of the force. When considering how much you can afford to spend each month, you will need to be completely honest about how much you’re already spending.
Add together your entire monthly debt payments. Credit card debt should be included in this list, unless you always clear your balance each month.
We’ll need to subtract your debt from your income when putting everything together.
Note: Don’t worry if your credit rating isn’t great. You can still get a car loan. Find out more in our feature on how to get a car loan if you have a credit score below 500.
Budget for buying a car #4: How much downpayment can you afford?
Downpayments have never been popular. It is easy to see why. Especially if a dealer insists on one, you may not be able to afford a car, even when you can meet all other obligations.
Then again, downpayments serve two quite sensible purposes: They (partially) protect lenders against a default and they reduce the total amount to be financed. The higher the downpayment, the smaller the risk and the cheaper the loan.
The latter part of that sentence deserves your attention. After all, one of your main priorities for good budgeting should be to keep total costs as low as possible. Paying a decent downpayment is one way of doing this.
But be careful: If the downpayment reduces your savings, it may actually increase your risk of a default in case you temporarily find yourself without an active income. The ideal downpayment should err on the side of caution.
Budget for buying a car #5: Setting the right length
As you probably know, most experts recommend you cap the length of a loan at roughly 48 months. This is not a random number. Many drivers like to change cars after this time. If you’re still paying off your loan after four years, you’ll have to pay off debt on a car you’re no longer using. It goes without saying that’s not healthy.
On the other hand, if you can not afford to pay the monthly rates on such a loan, that’s not healthy either. All of which means: Don’t let experts stifle you with these strict rules. Try to keep the loan term as short as possible, but as long as it needs to be.
Putting it all together: Part 1
Now, let’s get to work. In this section, we’ll explain how you can use the above mentioned information to create a realistic and workable budget.
- First, establish your monthly income.
- Add the projected trade-in to any savings you may have. This constitutes your spending power.
- Subtract all fixed costs from it to arrive at your disposable income.
- Then, establish how much you should be spending on transportation. Generally, 10% are given as a good number. This will most likely not be enough, however. 20% is what most people appear to be actually spending and it seems like a reasonable figure. Use this as the maximum amount you should be paying for your loan each month.
- To assess your debt situation, use the 36% rule. This rule specifies that you should never pay more than 36% of your income on debt. Make sure that you don’t exceed this number after you’ve added the loan payments to your overall debt.
Putting it all together: Part 2
The first three steps establish how much you can or should spend on your car loan. In the next section, we’ll work out the details:
- First, define the total costs of the purchase. The running costs are not part of the loan. But it makes sense to include these in your calculations to see if you can still meet the 36% target if they’re included.
- Then, set the downpayment. As we mentioned earlier, pay as much as you can but as little as necessary.
- Use our free online car loan calculator to find combinations of all variables that meet your monthly targets.
It goes without saying that we’re there to help if you can’t work out the budget yourself. Getting you behind the wheel again is our main goal. So don’t be afraid to get in touch – either by visiting our Manchester showroom, writing us an email or giving us a call.