The math you should do before buying the car of your dreams

High prices for cars, loans, and insurance demand a tight budget, keeping expenses below 20% of your income. When does something become too expensive? Spending more than 30% of post-tax income on rent makes a house or apartment unaffordable. The Department of Health and Human Services considers childcare costs over 7% of income as unaffordable. For cars, Joseph Yoon, a consumer analyst at Edmunds, an automotive information and resource service, explains that car payments should not exceed 10% of monthly income to consider a car affordable within your budget.

When accounting for fuel, repairs, and insurance, the total expense should ideally not exceed 20% to avoid financial strain. However, these percentages are maximum guidelines; the lower you stay under them, the better. Therefore, when you’re in the market for a car, avoid instinctively looking for the model that best meets your needs and desires, comparing and even letting yourself be carried away by dreams.

It is advisable not to do so. It’s not about crushing your dreams, but in these times of high prices, high interest rates, and high insurance premiums, it’s crucial to be very aware of your budget before falling in love with a car, which is considered the second largest family expense after housing. «The budget is more important than ever,» Yoon asserts, given the «astronomical» cost of vehicle ownership.

According to Edmunds’ long-standing data, the average price of a new car in the United States is currently $48,000, and in March, the financing interest rate was around 7.2%. Yoon explains that an average of $40,000 is financed over 62.7 months for new cars, with even longer loans available.

This means paying around $700 a month for a car over five years—a 40% increase from March 2019 and nearly $9,000 more in interest, a 40% increase since the pandemic began.

In the used car market, besides the price increase during the pandemic, loans come with an 11% interest rate, adding $10,800 in interest to the total car price, a 70% increase from pre-pandemic levels.

Yoon warns that the longer the loan term, the more interest paid, making the purchase more expensive despite lower monthly payments. Therefore, when planning a budget, it’s essential not only to consider what you can pay at the time of purchase but also how your budget will fare in the future, given the length of the loans.

If you pay for the car outright in cash, you save on interest, but it’s still crucial to use these percentages as references to calculate how long it took to save the money, Yoon explains. It’s also important to look broadly at personal or family finances. What amount aligns with the need to maintain retirement savings or an emergency fund?

Cars depreciate quickly, and their costs have risen, but at least, Yoon notes, they are more durable now, making the investment last longer because of higher quality. When estimating what you can spend, many online calculators can provide a close estimate to help make a decision.

Another important detail to examine in your financial situation if you need a loan is your credit score. Although there’s no minimum required to get a loan, the higher the score, the more options you have for obtaining credit with better interest rates.

Where to Get the Loan?

Financing the purchase through the dealership where you buy the car is common but usually the most expensive option because they typically offer loans with higher interest rates. According to the Consumer Financial Protection Bureau (CFPB), dealers offer purchase rates and interest rates that compensate them for managing the financing. However, buyers can also seek a loan from a bank or credit union, which tend to have lower rates.

Yoon advises comparing loans. «Often, dealers have incentives to offer better financing,» the analyst explains, recommending seeking the best deal and trying to get the dealership to match it. «It’s not that the dealership is the worst place to get a good loan, but you have to work a bit to get the best deal.»

If you see a dealership boasting that no credit checks are required or signs saying «buy here, pay here,» it’s because, as the CFPB notes, they offer financing to buyers without credit history or with low credit scores. There are two crucial points to consider in this case. First, the interest rates are higher, increasing the car’s final price.

Second, these dealerships often present themselves as an option to build or repair the buyer’s credit. In this case, make sure it’s true: ensure that no late payments are reported to avoid damaging the credit history, which opens and closes many doors.