Car Loans: how much is too much?

Aside from a mortgage, a car note may be the most significant loan you ever take out. But just because you have the ability to qualify for a car loan doesn’t mean that loan is fair or affordable. Many Americans today are driving around in cars they are paying too much for, and that is one group you certainly don’t want to join!

In this post, learn how much is too much to pay for a car loan and how to get a fair price on a car you can afford.

Calculate 15 Percent of Your Annual Income

Financial experts often advise clients to choose a car that will require them to dedicate no more than 15 percent of their annual income to repayment and expenses.

The average annual income nationwide is just over $53,000. So let’s say you make this amount. 15 percent is $7,950. So you will want to calculate the total cost of your new car on an annual basis to find out if the loan burden plus expenses will be workable for your financial situation.

Understand the Total Cost of a New Car

If there is one expense that new car buyers routinely forget to add into the sum total, it is car insurance. The truth is, some cars are just more expensive to insure than other cars.

For this reason, you should get a car insurance quote on the new vehicle you have your eye on before you decide to make the purchase. Then build that cost into your budget to see if your new car will be affordable.

Also be sure you have included each of the following expenses into your budget: gas, oil changes, routine maintenance, registration renewals, car insurance, loan payments.

Consider Using the 20/4/10 Rule

Another way to determine whether the car loan you are taking on may be too much is to use what experts call the 20/4/10 rule, which stands for the following:

20. The percentage of cash you put down initially as a downpayment.

4. An auto note that covers a 4-year repayment term.

10. A monthly loan repayment amount that costs no more than 10 percent of your monthly pay.

Here, don’t forget to calculate in any vehicle you plan to trade in as part of your down payment. It can be helpful to get a quote on your existing car’s trade-in value in advance so you know how much additional cash you will need to come up with for a down payment.

If you are tempted to choose a longer repayment period (many of today’s car loans can be stretched out over 5, 6, or 7 years), you may want to consider whether the car is really affordable for you, since you increase the amount you will pay in interest for each additional year of your loan term.

Check Your Credit Score, Then Seek Lending

Car buyers with excellent credit scores can qualify for the lowest interest rates on auto notes. If your credit score leaves something to be desired, you may want to contact the top credit repair companies for help before you buy a new car.

You can use this free tool to estimate how much you might save on a car note by improving your credit score.

Other factors that could improve your loan terms include putting down more money as a down payment (see here) and having a lower debt-to-income ratio. The latter tells lenders how easy or hard it may be for your to honor your debts.

Since everyone’s personal situation is unique, there is no one standard way to decide how much car loan is too much. But by evaluating your income and existing debt using these expert tools, you can decide how much car loan is too much for you.

Article written by

Kevin Faber has been in the commercial finance and banking industry for most of his professional life. He graduated at UC Davis with a B.A. in Business/Managerial Economics. His experience in credit analysis, finance, and management led him to be the founder of Silver Summit Capital. He enjoys working in the financing industry and building connections with industry leaders.

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