How to Choose the Right Car Payment

How to Choose the Right Car Payment article image.

When it's time to buy a new car, what's one of the first things you think about? How big your car payment will be, of course—and how to keep it as low as possible. After all, every dollar you spend on a car payment each month is one less dollar you can put toward savings, debt payments or fun stuff (like going out to eat, buying new clothes or traveling).

Choosing the right car payment will depend on several factors, including your monthly income and expenses, your current debt level, and the specific car you have in mind. But the size of your car payment is only one issue to consider when you go shopping for a car. Here's what else you need to factor in to the equation to get the best deal.

Figure Out How Much You Can Afford

Start by assessing your monthly income and expenses. It's especially important to consider your debt payments, such as mortgage payments, student loan payments and credit card payments. Lenders will look at the ratio of your total monthly debt obligations to your total monthly income when deciding whether to approve you for an auto loan. Ideally, your debt should be below 40% of your monthly income. Learn how to calculate your debt-to-income ratio.

If your debt-to-income ratio is in good shape, assess the rest of your monthly expenses to see how much you can spend on your car. In addition to the car payment itself, be sure to consider the other expenses of owning a car, such as insurance, repairs and gas. In general, your monthly car expenses shouldn't exceed 20% of your monthly net pay.

If you need to free up more money for a car payment, think of ways to reduce both fixed expenses (like your utilities and rent) and variable expenses (like groceries or online subscriptions). Get more tips on how to make a budget to understand where you might cut back to help fund your car payment.

Look at the Auto Loan, Not the Car Payment

The cheapest car payment isn't always the best option. Why? Choosing the lowest car payment often means you end up paying more for your car in the long run. To lower your car payment, you typically need to stretch out the length of your loan. Over time, that means paying more interest.

Suppose you want to buy a $20,000 car and have a $2,000 down payment, so you're financing $18,000. A 48-month (four-year) loan at 5.09% interest will have monthly payments of $415. The interest on this loan will cost you $1,933 over four years.

What if you want to reduce your car payments? Stretching the same loan out to 60 months (five years) lowers your monthly payment to $340. However, over time, you'll pay $2,425 in interest. Extend the loan to 72 months (six years) and your monthly payment drops to $291—but your total interest paid rises to $2,926.

Instead of comparing the different car payments you can get, compare different loan offers. Do this before you ever head to the dealership. You can look up current average interest rates on auto loans online. A good strategy is to get preapproved for an auto loan so you know what loan terms you can get from a bank—then have that preapproval with you when you consider the dealer's offers.

When comparing loans, look at the amount borrowed, the length of the loan and the annual percentage rate (APR) to assess the ultimate cost. The APR represents the interest rate on the loan as well as any fees involved; compare APRs for loans of the same amount and duration to determine the best deal.

Other Ways to Get Low Monthly Car Payments

There are plenty of options to lower your monthly car payments and make your car more affordable.

  • Improve your credit score. A higher credit score qualifies you for better loan terms. If your credit score is only fair or poor, wait a bit to buy your car until you've improved it. Find out how to improve your credit score.
  • Save for a larger down payment. The more you can afford to put toward a down payment, the lower your monthly car payments will be. A bigger down payment also reduces the loan amount you'll need, helping to keep your overall debt manageable.
  • Lease the car. If you're craving a new car but can't afford the monthly payments to buy one, leasing generally offers lower monthly payments for the same type of vehicle. Just make sure you understand all the costs involved, as well as restrictions such as mileage limitations, and remember that you won't own the car when the lease is up. Learn more about leasing a car to find out if it's right for you.
  • Look for a less expensive or used car. Today's late-model used cars offer many of the same extras and features as brand-new models at significantly lower prices. If you don't want to buy a used car, set your sights on a less expensive new car. You'll have lower monthly payments and still get to savor that new-car smell.

To get the best possible auto loan, get a free credit report and check your credit score three to six months before you start shopping for a car in earnest. When you get to the dealership, the dealer may try to get you to focus on lowering your monthly payment—often with a longer-term loan that costs more in the end. Don't let them dissuade you. Focus on the total cost of the car loan, not the monthly payment, to get the car you want at an affordable price.