The average monthly car payment for a new car is currently $729, while the average payment for used cars is $528. Recent data suggests over 15% of buyers were paying over $1,000 a month at the beginning of 2023. Insurance is also pushing new records, at an average of $2,014 per year or $169 per month. In this story, we’re going to go over how much money you can actually afford to spend on your next vehicle.
The increasing cost of new cars is down to two factors, vehicle price and financing. New models have gotten increasingly expensive over the past years, and it’s pretty fair to say that anything under $30,000 (new) isn’t that enticing. In addition, the average APR has gone up, and it can go over 10% if you have a bad credit score.
Basically, dealerships want to sell you expensive cars. They stretch out the loan period to about 70 months and that pushes your costs. To avoid this, here are some basic rules you must follow when making your next buying decision.
The 35% rule
The 35% rule states that you’re not supposed to spend more than 35% of your gross annual income on a new car. That means if you’re making $60,000 per year, you should spend more than $21,000, enough for a Chevy Trax. And if you make $100,000, you can go up to $35,000, almost enough for a base Lexus or Audi crossover.
Most interesting new vehicles like a Corvette or Hummer are in the $100,000+ range. But to afford that, you’re supposed to be making $350,000 a year.
It sounds pretty bad, but the 35% rule is made for car enthusiasts. The classic rule that you’d hear from financial experts like Warren Buffett is 20%. Ouch!
20-4-10 rule
The 20% rule isn’t designed for modern times. It was created in the golden age of the American economy. A more modern rule is “20-4-10”, designed for the modern way in which a car is financed. It states that you’re supposed to make a 20% down payment, finance the car for 4 years (or less), and have a monthly payment of 10% or less of your income.
But why? Well, that 20% shows you’re a responsible buyer. It can also be your trade-in car. Having a 4-year loan instead of a 6-year one does mean you pay more per month. But the extra interest you pay over those 2 years is currently about $1,500 on a $30,000 loan even with interest as low as 5%.
Examples of cars you can buy
Right now, the most popular car in America is the Toyota RAV4. The 2024 model starts at $28,500. But you want a hybrid with AWD and a few options, which is going to cost about $35,000.
Following the 20-4-10 rule, you’ll need a $7,000 deposit and will be paying about $645 for 48 months (optimistically). And to be eligible, you’ll need to make $645x12x10=$77,400.
So basically, you can’t afford anything nice. Can you do anything about it? Well, you can buy used. Most of the depreciation of a new car happens within the first 3 years. That age of car will still have most of the latest features and might bring the status you’re after.
Auto loans are typically made in 12-month intervals, with 60 and 72 months being the most common. But 84-month or 7-year loans are becoming popular. But in most cases, that’s a terrible idea because you’re paying a lot of interest on an asset that will have lost 60-70% of its value by that time.
Another smart idea is to go for the models that will have good resale value in another 3 years and are still covered by the manufacturer’s warranty. EVs are a big unknown because they seem to depreciate very fast, but hybrids continue to be in demand.
Consumers are getting smarter. On new vehicles purchased in 2023, 79.70 chose to finance their vehicle, down from 83.49 percent in 2022. You might also want to use Edmunds’ True Cost to Own (TCO) calculator, which estimates everything: depreciation, taxes, financing, fuel, repairs, insurance, and maintenance.
