A typical American puts 11% down on a car, spends 11% of their PRE-Tax monthly income on a car payment according to Edmunds.com , pays 4.13% interest rate on a car loan and has an average loan duration of 62 months (as of 2011)
But those averages are not necessarily great financial decisions! Know your own budget first. Know what you can afford without sacrificing lots of other things before looking at auto calculators! If you have about $1000/month in (BLUE) discretionary spending (eating out, clothes, kids activities, etc.), think about spending about $450 on a car payment so you have money for fun things. You may qualify for a loan that would give you higher monthly payments, but you should decide what you can handle not what the bank is willing to lend (banker’s calculation here).
The best financial decision is to buy a used car with cash, but that’s not always possible. You want a reliable used car and you don’t want to take cash out of your emergency savings, retirement or home equity to pay for it. Not everyone has that kind of cash lying around. If you don’t, it makes sense to finance a used car and save for a few months for a down payment only.
If your current car is costing you a lot in repairs, or is unsafe, it makes sense to save only for the down payment as soon as you can and buy a good used car to stop hemorrhaging money on your old car.
You want to have the least amount of time where your car is worth less than what you owe (called “upside down”). To decrease the amount of time you’re upside down, BUY USED! And do the following:
- Down payment – put as much down as you can – at least 12-20%
- Loan Duration – as short as possible and no more than 48 months
- Pre-tax monthly income on a car – no more than 8% (try to stay below it)
- Interest rate – 0 -4%. Watch out for extra fees when you get an interest rate deal. Loans on used cars can have higher rates, but it’s worth it for less time upside down.
Bearing all this information in mind, let’s work an example and see what a real car might look like:
- Monthly Car Payment: $450 (6.4% of PRE-TAX household monthly income where annual income is $85,000)
- Loan duration 48 months
- Interest rate 3.85%
- Downpayment of 15% ($4,125)
- Car Value = about $27,500 (whether new or used, but you will get more car buying used!)