How to Calculate an Affordable Car Payment

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If you drive a car, you know that paying for transportation can get expensive. That's why it may be helpful to get a low monthly payment on your vehicle upfront. Figuring out how much you should pay for your car payment can be tricky, but calculating your budget in advance can help you get a picture of what size payment will work for you.

How to Calculate an Affordable Car Payment

It's important you know how much you can afford to pay each month before you go car shopping. To figure this out, take into account all your monthly bills—such as your rent or mortgage, utilities and debt payments—as well as food and other necessary costs. After calculating all of your monthly expenses, take a portion of what's left—how much will depend on your lifestyle and income—and earmark it for your monthly transportation costs.

Another way to calculate how much money you'll have for a car payment is with the 50-30-20 rule, which is a popular budgeting ratio. With this method, you take your after-tax income and divide it into three portions. The first 50% goes toward necessities; the next 30% goes to things you want; and the final 20% is for savings.

The 50% for necessities includes obvious items like your rent or mortgage, utilities, health care, food, debt payments, transportation costs and any other unavoidable costs you have each month.

The 30% for things that you want includes entertainment costs, retail purchases and other spending for your enjoyment and quality of life. The key with this portion is to try to limit yourself as much as possible so that anything left over can be put toward savings.

The 20% for savings is simple, and these funds can be allocated as you wish depending on your specific saving goals. Some could go toward a retirement account; some could be put toward an emergency fund; and some could be kept in a general savings account.

For most people, transportation costs are considered a monthly necessity, and using the 50-30-20 rule can help you figure out exactly how much this amount should be. Once you've taken 50% of your post-tax income, subtract all your monthly bills, and what you're left with can be used as your transportation allowance. Depending on your income, this leftover portion might be quite large. In this case, you don't have to use all of it for transportation; you can put any extra toward saving.

Remember that owning a car means paying for much more than just the monthly loan payment, so be sure to account for all transportation costs when trying to calculate your car payment.

Consider Total Transportation Costs

Because your car payment is only one part of your overall transportation costs, you should also be prepared to pay for gas, maintenance and upkeep, insurance, tolls and other related expenses. Your transportation budget should include everything listed above and a little buffer in case of an emergency or extra unforeseen costs.

While your gas, insurance and maintenance budget will be partly based on what type of car you have, roughly estimate these costs and deduct them from your overall transportation allowance. The remaining portion should give you an idea of what you can afford to pay for a car payment each month.

Calculate How Much Down Payment You Can Afford

A down payment is money you pay toward the vehicle sale price before taking an auto loan. So when you purchase a $15,000 car and put $1,500 down, for example, you'll need to finance $13,500. Because the amount you put down will change how much you need to borrow, knowing what you can afford to put toward a down payment in advance will help you gauge how much your future car payment will be.

How a Car Payment Works

Just like any other loan, a car payment will have interest and a set term. Depending on your financial situation and creditworthiness, your car payment could be much more or much less than someone else's, even for the same vehicle. It's important to understand how these payments are calculated so you know if you're getting the best deal possible.

First, be aware of the term, or over how many months your loan will be spread, because the longer you're paying interest, the more expensive the car becomes.

Imagine these scenarios:

  1. You put a $1,500 down payment on a $15,000 car. Your interest rate is 5.35% and the term of the loan is 48 months. With this calculation, you'd be financing $13,500, and your monthly payment would be $313. The total interest paid on the loan would be $1,524 over the life of the loan.
  1. Now imagine buying the same car as above, but instead your loan term is 60 months. With the same interest rate, your monthly loan payment goes down to $257, but your total interest paid increases to $1,920.

While a shorter-term loan will typically have a higher monthly payment, the total cost will usually be less depending on your interest rate and term. If you can afford it, paying more each month will allow you to get rid of your car payment quicker and pay less in interest.

How to Bring Down Your Car Payment

There are many ways to save on your car payment, and just because you can afford a certain amount each month doesn't mean you should plan to pay that much. Here are a few ways you may be able to get a lower car payment:

  • Buy a used car. Used cars often cost much less than new vehicles, which means that your payments may be lower, depending on what your interest rate is. Used cars also may help you save on insurance, as your lender may have relaxed requirements on the extent of coverage you need to carry.
  • Make a larger down payment. Consider saving for a few extra months so you can beef up your down payment when going to buy a car. Every extra dollar you pay in your down payment is one less that you'll have to finance and pay interest on over time.
  • Consider a lease. Car leases often have lower monthly payments than car loans. Because you won't have any equity in the car after the lease term ends, car dealerships can often offer lessees new cars at a fairly low monthly rate. Lease agreements typically set a mileage limit and may have maintenance requirements, so make sure to run the numbers and look into all the details beforehand. Also keep in mind that while a lease may lower your monthly payments in the short term, you'll pay more in the long run because you will always have a monthly car payment. When you buy a car, ideally you'll keep the car for a period of time after you pay it off, which brings your monthly payment down to zero.
  • Improve your credit. Interest rates are often based on creditworthiness. Improving your credit score before going car shopping may help you get a better interest rate which will save you money over the life of your loan.

Consider Improving Your Credit Before Applying

If you're financing your new car and think you might be able to get a lower interest rate with a higher credit score, consider working on your score for a few months before making a purchase.

The best way to improve your credit score is to make all your debt payments on time, as this is the biggest factor credit scoring models consider when calculating your score. Also pay close attention to your credit utilization, or amount of available credit you're using, which is the second-largest factor in your credit score. Be on the lookout for any inaccurate information that might appear in your credit reports. If you find something in your reports that shouldn't be there, file a dispute with one or more of the three major credit bureaus (Experian, TransUnion and Equifax) to see if you can get the information removed from your report.

Consider getting a free copy of your credit reports and credit scores from Experian to understand what a lender will see when they consider you for new credit.

Financing a car can get complicated, so determining how much you can put toward a monthly payment before going into a dealership will help you make sure you're getting a car you can afford.