The 20-10 Rule For Car Buying Everyone Must Follow

Buying a car is a major purchase for most people. The last thing you want to do is buy more car than you can afford. I'll help you be prepared for you next auto purchase. If you take the car buying process one step at a time and put some time into researching your purchase and your finances, you can make sure you don't go "car poor".

What Can You Afford?

You want to buy as much car as you can afford, but how much can you afford in the first place? Start out by figuring out a payment amount you can handle before you start looking.

Start with your budget. How much room is there in your budget? Could you, for example, fit an extra $200 a month in your budget without strapping yourself too much or eliminating your savings? If so, can you fit an extra $300 a month in your budget? No? How about $250? 

Continue that process until you have a general idea of how much you extra room you have in your budget. That's how much you can afford to pay for a car every month. Operating expenses can be as much as 1/3 to 1/2 of the monthly cost of a new car. So take the amount that fits in your budget and multiply it by .66. That is the most you should consider spending on monthly payments for the vehicle to be able to afford operating expenses as well.

Remember that your expenses will include not only your car payment, but also your insurance, gas, maintenance and other miscellaneous costs associated with operating a vehicle. As a general rule, the more expensive the car, the more it costs to insure and maintain it.

The 20-10 Rule

Never borrow more than 20% of your yearly net income

If you earn $400 a month after taxes, then your net income in one year is: 12 x $400 = $4,800 Calculate 20% of your annual net income to find your safe debt load: $4,800 x 20% = $960 So, you should never have more than $960 of debt outstanding. Note: Housing debt (i.e., mortgage payments) should not be counted as part of the 20%.

Monthly payments shouldn't exceed 10% of your monthly net income

If your take-home pay is $400 a month $400 x 10% = $40 Your total monthly debt payments shouldn't total more than $40 per month.

Down Payment

The bigger the better.

Cash is a great symbol of your commitment to make all the payments to a dealership. That's the basic idea of a down payment.

To get a loan for a car, and often for a lease, you'll probably need to make a down payment of around 10% of the total price of the vehicle. The larger your down payment, the smaller your monthly payment will be and the less you will pay in total for the car in the long run. But make sure you don't break yourself or deplete your savings account with too large a down payment.

It's important that you know you will need a large sum of cash when you buy a car. If you can, delay purchasing a car so that you have some time to save up a decent down payment.

Now that you know how large a monthly payment you can afford, you can start looking to find out how much car that will get you.

Remember, owning a car can be expensive. You should consider all of the following before making that purchase:

Costs of Owning a Car
  1. Initial purchase price
  2. Registration and title costs
  3. Sales tax and GST/HST
  4. Financing costs
  5. Depreciation
  6. Insurance
  7. Scheduled maintenance
  8. Storage (renting garage space)

Costs of Operating a Car
  1. Gasoline
  2. Maintenance and repairs
  3. Tires
  4. Parking and tolls
  5. Tickets
Keep Track Of Your Net Worth: Hopefully you are now able to afford the car you want instead of going into deep debt and buy a car you can’t afford. The easiest way to grow your wealth is to know where all your money is going. Sign up for Personal Capital, the best free financial tool on the web. I use them and have seen my income and net worth blast off. They keep me motivated to budget, spend and invest wisely.