Here's how to calculate how much you can afford to spend on a car (2024)

A car is often one of life's biggest expenses, but how much should you actually spend on your vehicle?

There's no one-size-fits-all formula, says Patrick Roosenberg, senior director of automotive finance intelligence at J.D. Power. Instead, the car-buying process is a nuanced adventure, dependent on your needs, your financial situation and the terms of your loan.

Here, CNBC Select breaks down how much you should budget for buying a car.

Set a monthly budget

If you're going to be financing a vehicle purchase, it's important to create a budget before heading to the lot to determine how much you can comfortably spend monthly on an auto payment. And even that number should be a guideline, not a goal. Frugal spenders can happily get off the lot with a much cheaper vehicle, advises Roosenberg.

Roosenberg added that not only should you consider your current budget, but you should consider your future budget as well. "You're committing to a long-term financial agreement," he says. "So you have to say, 'How am I right now?' I have to project what I'm going to be able to do for the next four, five, six years. Am I gonna be comfortable with making that level of commitment?"

If you need a soft guideline, Roosenberg advises spending no more than 20% of your post-tax monthly income on your car payment. But, keep in mind that number can vary depending upon your state's cost of living and your outstanding debt, according to Roosenberg.

However, don't treat 20% as a goal. If you make $5,000 a month, you shouldn't necessarily be searching only for cars with a monthly payment of $1,000. Instead, understand that benchmark as a limit and look for the cheapest car that checks all your boxes.

And before you spend a large chunk of money on a car, make sure the rest of your finances are in order. You can follow the 50-30-20 budgeting rule, which suggests using 50% of your money for needs, 30% for wants and 20% for savings. For example, it might not be the smartest idea to drive off with an expensive car if you are behind on saving for retirement or you don't have an emergency fund.

Budgeting apps can be helpful tools to help you stay on track. For example, Goodbudget makes it easy to divvy up your cash into different spending categories with each category having its own envelope. You could make an 'envelope' for your monthly car payment.

Financing a car vs. paying in cash

A 2023 study from CDK Global found that 29% of people surveyed purchased their latest vehicle in cash. There are several key differences between financing your car with an auto loan and paying for it entirely upfront.

When you pay in cash, there are no interest costs, which can total up to thousands of dollars over the life of a loan. For example, if you put $5,000 (20%) down on a $25,000 car, financing the remaining $20,000 at 5% for 48 months would result in over $2,100 in interest charges. Further, paying in cash allows you to own the car immediately and absorb it into your financial portfolio as an asset.

When you finance a car, there may be lower upfront costs, usually just a down payment and any fees from the dealer. Financing a car comes with interest costs, as described above, and any fees attached to the loan (like lender's fees), according to L.A. Financial Credit Union. Dealer fees can range up to 10% of the vehicle's cost, according to Autotrader.com. Those fees will be wrapped into your loan, and you will pay down the combined total throughout the loan.

Factor in additional expenses

It's no secret that cars are expensive, depreciating investments. Not only have interest rates gone up since they bottomed out in 2020 and 2021, but the cost of vehicles has also gone up since the pandemic. "It's a double hit," says Roosenberg.

Used cars have lower list prices and lower monthly payments than the equivalent new car, but depending on the car, you could be jumping into a chasm of future maintenance costs, so it might not be worth getting the cheapest, oldest car on the lot just to save a buck upfront, according to Experian.It's also important to factor in other expenses, like car insurance premiums and gas into your budget.

Keep in mind, however, that estimates are just that — estimates. "Until you [are] actually offered contract terms, you're not going to know the rate, you're not going to know the total amount borrowed. You're not going to know the term," says Roosenberg.

Use a loan calculator

If you're looking to estimate monthly payment estimates before signing your name on the dotted line, CNBC Make It offers a handy loan calculator. This can help you determine whether a car loan will align with your budget and is much easier than creating an amortization schedule by hand. Don't forget to subtract your down payment from the list price of the car to calculate your total loan amount.

Consider these top auto lenders

An auto loan allows you to borrow money to purchase a car. You'll then have to pay off the loan with fixed payments over a set period, usually between 2 and 7 years. These loans may come directly from the dealer, a bank or credit union or online lenders.

While financing with a dealer will save you a trip elsewhere, dealers tend to have the highest interest rates, according to the Consumer Financial Protection Bureau. Consider instead using one of CNBC Select's top-rated auto lenders and shop around for a loan with the best terms and lowest interest rate.

One of our top picks for auto loan lenders is PenFed Auto Loans. This credit union lender offers affordable rates and flexible loans. Additionally, you can prequalify for a loan and see estimated terms without a hard credit check.

As with any other type of loan, the bigger your down payment and the shorter your loan term length, the less you'll pay in interest charges over the life of the loan. However, paying down your debt too aggressively can also cause financial strain in paying for other ongoing expenses.

Take advantage of car insurance discounts

One of the largest costs of vehicle ownership is car insurance, Roosenberg says.

An easy way to save is by maximizing the car insurance discounts available to you. Insurance companies offer various discounts, such as for being a safe driver and for bundling your home and auto insurance. You can also get a lower car insurance rate (and a better loan interest rate) with a high credit score.

If you're searching for cheap auto insurance coverage, consider Geico. It offered some of the most competitive premiums forfull coverage car insuranceof the companies we reviewed, including 16 different types of discounts available, and consistently receives high ratings for customer satisfaction.

Other tips to save

To save even more, consider shopping around at multiple dealerships, looking at lightly used cars instead of new ones and taking advantage of trade-in offers for your old car. Perhaps most importantly, you'll want to thoroughly read and understand the terms of the loan as there may be features you can negotiate, such as the interest rate and down payment.

"Just based on my studies, consumers are doing more research before going to [the] dealer than ever before. So, you can go out there on the internet and do some price comparison," says Roosenberg.

Understanding a car's true market value can help you negotiate with the dealer and let you know when to walk away, according to Consumer Reports. Kelley Blue Book is an industry-standard resource for comparing sales prices for specific makes and models.

Roosenberg reveals that one of the biggest mistakes consumers make in the car-buying process is accidentally revealing their cards to a dealer. "You don't want to go to a dealer and say, 'Well, I can do $400 a month.' You want to know what your budget is, and then negotiate the price of the vehicle. Hopefully, you can get it within your range."

There's no perfect formula to calculate how much car you can afford. "Formulas are great to kind of see what's a guideline, but the hard-and-fast rule is: What can you afford?," Roosenberg affirms.

When you shop for a car, don't overspend. Do your homework so that you can drive off the lot with a competitive loan package and car insurance premium in the passenger seat.

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