Assessing Affordable Car Loans
This calculator can be used to help determine how much you can pay for a new car based on how much you want to spend each month on your loan. The calculator needs a total of seven inputs, including:
- The monthly amount of money you’d like to spend to repay a car loan. This is your desired monthly car payment
- If you already own a car and would like to trade it in as part of the new car’s financing, input the car’s trade-in allowance. If you’re not trading in a car, make this value zero.
- If you plan to put a down payment on the car, enter that value. Typically, lenders will require a borrower to make a down payment before writing the loan
- If you have an outstanding car loan that needs to be paid off, then enter the outstanding balance on that loan
- The rate of interest charged on the loan, also known as the finance charge
- The term, or duration, of the loan stated in years
- If you live in a state where there is a sales tax on new cars, enter that value here
The calculator then provides the user with five outputs, including:
- The amount of money available via the loan, which is a function of the interest rate, desired monthly payment, and loan term
- The upfront cash provided as part of the transaction, this includes the trade-in allowance, plus the down payment, minus any outstanding car loan to be paid off
- The total of all payments that can be made towards a new car
- The sales tax owed (if any)
- The net price that can be paid for the car (net of sales tax)
How Much Car Can I Afford?
Unlike a mortgage where there are several qualification rules that dictate how much you can spend on a home, understanding how much you can spend on a new or used car is not so straightforward. The monthly cost of a car loan is a function of interest rates, the amount borrowed, and the term of the loan, which is the timespan over which the monthly payments are made to the lender. For example, a 300 per month payment at 5.500% for two years allows you to borrow 6,800. At the other extreme, a seven-year loan with the same monthly payment and interest rate would allow you to borrow nearly 21,000.
To answer the question: How much car can I afford? You need to really focus on two of the three variables – monthly payment and term (or length of the loan). The third variable, the loan’s interest rate, is important but is not under the borrower’s control. Focusing on the variable you can control, ask yourself these two questions:
How long do I intend to own the car?
How much discretionary income would I like to spend on a car each month?
This first question is an important one because it helps you determine the term of the loan. It is unadvisable to take out a seven-year loan if you only intend to own the car for three or four years. When you go to sell or trade-in the car, you will also need to repay the remaining balance on the loan. This brings us to our first rule of thumb:
The term of the loan should be equal to or shorter than your planned ownership timeline
If you plan to own the car for five years, then the term of the loan should be five years or less.
Our second question deals with discretionary income. This is income that is left over after paying for essential expenses such as rent, a mortgage, and other monthly bills (electric, gas, cellphone, and even streaming services). Essential expenses also include transportation costs to work, funding retirement or rainy-day accounts, clothing, food and even some entertainment costs. After subtracting all these monthly costs from your monthly income you’re left over with your truly discretionary income, which brings us to our second rule of thumb:
The monthly loan payment should be less than or equal to your discretionary income
Breaking this second rule of thumb can result in a household that is car rich and cash poor.
Interpreting the Results of Our Calculator
The calculator presents your results in a straightforward manner. Once the monthly payment, term, and interest rate is entered the calculator knows how much money you can borrow. The calculator also accounts for trade-ins, up-front deposits, and the possibility of paying-off an existing car loan. These values tell us how much cash the borrower will be providing as part of the transaction. Finally, in some jurisdictions a sales tax may also be due. Normally, this is not an important consideration, but given the cost of a new car the sale tax can be 1,000 or more. That is why the calculator provides a net car price, which accounts for the payment of sales tax too.