Here’s a question we keep getting from our customers: How much of my income should go towards my car?
It’s a perfectly sensible thing to ponder. Cars are expensive, after all. And if you’re like most of us, your income will be limited. So there’s every reason to start looking for guidelines on how spend it safely.
In this article, we’ll give you an overview of the most famous concepts towards car finance. We’ll go through the different approaches and separate the wheat from the chaff.
At the end, you should be able to decide pretty exactly how much of your income should be spent on your car.
Rules, rules, rules
One way of getting better deals is to look for innovative concepts in car finance. Perhaps you’ve already heard about car subscription services, for example. Or maybe you qualify for a student car loan. Mostly, however, if you browse the Internet for advice on car finance, you’ll quickly discover one thing: It’s filled to the brim with rules.
Usually, no one’s particularly fond of rules. In this case, however, it’s easy to see why strict rules can be appealing. When it comes to finance, a lack of discipline is precisely what gets us into trouble. A missed payment here, a little too much debt there … it all adds up and can quickly bring down your credit score.
So the stricter the rule, the better your chances of actually sticking to it.
And there’s another thing: When it comes to expensive items like cars, there is very little value in vague suggestions. You’ll want to know exactly how much to spend, not just ‘a little’ or ‘a lot’.
In this article, you’ll find six rules on how much of your income to spend on a car. That may seem confusing at first. But as we’ll show, there are really just three, which you can adjust to your needs.
Let’s begin with the 36% rule.
The 36% rule is an excellent point of departure, because it is probably the most widely suggested concept for determining the ratio between your income and car price.
The 36% rule goes as follows:
Your total loan payments in a month should not exceed 36% of your net income.
That’s it. Without a doubt, the rule is simple and straight-forward enough. But is it any good?
What we like about the 36% rule
The 36% rule is different from almost every other rule in this article in one important regard: Instead of isolating car finance and putting a number on it, it takes the larger picture.
Your car loan, after all, is part of a package of responsibilities. If you’re already paying off many larger loans on, for example, even spending as little as 5% of your income on your car may be too much.
What we dislike about the 36% rule
As with so many car finance guidelines, there is no objective reason, why the exact number should be 36%. Sure, it’s a rule of thumb, but where does it come from? Why are 35% okay, but 37% are considered too much?
Also, if you really think about it, 36% are actually quite a lot. In the USA, these high constant levels of debt are quite normal. In the UK, they’re not and for a reason: The higher your debt level, the lower your immunity to sudden financial shocks.
Ultimately, the 36% rule is not bad. But is may just be a tad too lenient on the overall debt level.
The 15% Rule
In its more expansive form, the 36% rule can become quite complicated. This is why some prefer the 15% rule.
Essentially, it’s the same as the 36% rule, but uses less optimistic figures. According to this rule, you should not spend more than 15% of your net income each month on car expenses.
What we like about the 15% rule
The 15% rule is simple and precise. It states exactly what the limit is for spending on your car. It is also slightly more cautious than the 36% rule. Whereas the latter approach could potentially mean that you’re spending all those 36% on your car alone, the 15% rule is more prudent.
If your budget is limited, this is anything but a bad thing.
Another advantage: With the 15% rule, you can start crunching numbers straight away. Just work out what your monthly income is after taxes and deductions and then use 15% of that as your yardstick.
What we dislike about the 15% rule
The 15% rule only applies if you’re not paying off any other loans other than a mortgage. It’s easy to see how that is a problem. Precisely those with financial problems will quickly exceed these numbers.
So the issue is twofold: On the one hand, 15% can still easily be regarded as too much. (we’ll get to that in the next paragraph) On the other, in practise, even 15% may not get you anywhere near a decent car, depending on the deal you can get.
Which is why the next two variations deserve your attention.
Variation #1: The 10% rule
As with many rules in life, you eventually realise that even the sensible ones may not apply to you. And so, there have been various variations on the 15% and the 36% rules.
The first is to reduce the percentage to 10%. We could think of many ingenious explanations on why this number was chosen. The real reason, however, is more trivial: It’s a more careful approach and will protect you against financial disasters.
Do we recommend it? Probably, yes. But we are also aware that the reality is that most people will already be hard pressed to make things work with 15%. The fundamental question is whether or not you can keep your income stable for a longer period of time. If you can guarantee this, then even higher percentages shouldn’t be a problem.
Variation #2: The 15/22/36% rule
We mentioned before that the 15% rule is anything but ideal. A way to get around the issues is to combine and add to the 15% and the 36% rules:
- Keep the car loan repayment costs to a maximum of 15% of your net income.
- Keep your total car costs to a maximum of 15% of your net income.
- And keep your total debt repayment costs below 36%.
This way, you’re getting both a very precise and a very comprehensive indication of how much of your income should go towards your car. The 15/22/36% rule is one of the greatest tools at your disposal to arrive at a sensible budget decision for your new or second-hand car.
But there’s even more.
The 1/10th rule & the 20/4/10 rule
Especially compared to the variation we just showed you, the following two rules can seem somewhat crude. However, they are useful if
a) you know for certain you are capable of covering the monthly car costs and
b) you’re just interested in determining how much of your income you can dedicate to the purchase price of the vehicle.
The 1/10th rule says that the purchase price of the car should not exceed 10% of your yearly net salary.
The 20/4/10 is a more detailed variation to this approach. This is what it comes down to:
- Never go for less than a 20% down payment.
- Never exceed a four year auto loan.
- And never pay more than 10% of your annual salary on a car.
What we like and dislike about the 20/4/10 rule
There are many laudable components to this rule. It is easy and to the point and it comes with concrete expert recommendations. If you search for the ideal loan repayment period, for example, you will find plenty of examples which suggest four years is the best time frame.
So, in many respects, this rule has its sources down straight.
On the other hand, it is not an approach that will work for most people. A 20% downpayment will stretch the limits of most people’s budgets. As will the monthly loan payments of a four year car deal.
And if your salary is very low, you will be hard pressed to find any car at all at a rate of 10%.
The big summary
This is why we recommend tweaking the 20/4/10 rule and combining it with the 15/22/36 rule.
Instead of going for too concrete numbers, consider the following:
- A downpayment is always better for both sides. Never just flat-out reject paying one. Instead, consider whether you can save some money first and then make at least a small down payment. This will keep the costs of the loan low and help you bring down the repayment period. If you can not make 20%, maybe 10% are possible?
- Paying off a car within 4 years is hard. But paying it off over the course of 8 years may make it unnecessarily expensive. Try to find the sweet spot between these two extremes.
Finally, use 15% as a yardstick when it come to the purchase price, as 10% seems too cautious. Being careful is important. But being overly prudent won’t get you behind the wheel again.