Whether you’re about to go car shopping or you already have a garage filled with cars, you need to know how much car you can afford. This concept will keep you financially stable and let you live happily with plenty of money in the bank. In this article, you’ll learn why it matters and how to find out how much car you can afford.
Why Does it Matter?
The simple fact is that you should never overpay for anything in your life. If you pay too much money in one area of your budget, you won’t be able to afford the other areas.
This is especially true in cars for a few reasons.
Depreciation of Cars
The first reason is that your car’s value goes down the second you drive it away from the car lot. When you put a single mile on a car, it becomes a used car and the value gets slashed.
Within three years, your car goes down an average value of 40%. That means if you spend $50,000 on a car today, it will sell for $30,000 in 2024. That’s twenty thousand dollars gone just like that. The same story is true for any type of car – the longer you own a car, the less it’s worth. This idea is called depreciation.
In general, a car is the most expensive item that depreciates that the average American will buy. If you overspend, you’re just throwing that money away.
The Cost of Cars
The next point is that cars are definitely not cheap. Next to your home, your cars might be the second-most expensive items you own. Unless maybe you have a shoe obsession.
So you’re making a huge financial decision when you decide to get a car. If you’re wrong and you get a car you can’t afford, you’re on the hook for a lot of money.
It’s Hard to Get Out
After signing the paperwork, it’s really hard to get out of a car loan. If you want to get rid of your car, you’ll end up paying the bank all of the money you owe.
Some people think they can sell their car and quickly get a new one. The process of buying another car is stressful, and so is the act of finding a buyer for your current car. If you go to the dealership, they’ll underpay you for your current car and overcharge you for the replacement.
In either case, you’ll still have to pay the remaining balance of the car. It’s a really tough decision to get out of.
Missing a Payment Really Hurts
So what happens if you’re a little short one month? Car companies are as forgiving as the banks backing them. In other words, they aren’t there to help you.
They want as much money from you as possible. If you miss a payment, you can expect the next one to have a slew of fees and penalties added on top of it. Miss enough payments and the bank will come tow your car away and repossess it.
All the while your credit score is getting dinged which makes it even harder to get a car in the future. Sounds fun, right?
How Much Car Can You Afford?
This leads us to the main question of this piece – how much car can you afford? If you ask your broke uncle, he’ll have a different answer than your rich friend. The truth is that a lot of people are overpaying for their vehicles for no real reason.
The equation works like this: take your household income and divide it by two. That’s how much you can have in cars for your house.
Determining Household Income
A household income is not a familiar term to a lot of people. It simply means how much money do the adults of the house make a year. If you’re married, then take your salary and your spouse’s salary and add them together.
What if someone is hourly or has a fluctuating annual income? Guess as best as you can or take an average from the last 3 years.
Determining the Worth of Your Cars
Your cars’ worth in this equation isn’t the same as their current sale price. It’s the amount of money you bought them for / how much you currently owe on them.
Having an older car that’s currently worth $10,000 but you bought it for $35,000 means that it’s a $35,000 car in this situation.
Just like in math class, we’ll use a quick example to help get the point across.
Sally and Mike are married and live together. Sally has a $10,000 Camry that she bought used a few years ago and Mike has a $50,000 2017 Ford Raptor. Added together, their cars are worth $60,000.
Sally is a teacher and Mike is a contractor. Their combined salary is $150,000.
In this case, they can afford to own up to $150,000 divided by 2. That’s $75,000 worth of cars. They own less than that, so they passed the test.
Help, I Can’t Afford the Cars I Have
If you just did the math and your heart sank, it’s going to be okay. Buying more car than you can afford isn’t the end of the world. If you keep those cars, then you’ll struggle – so we’ll have to get rid of them and get new cars.
How do you do that? You line up a buyer for your cars. Settle on a price according to kbb.com. Whatever the difference is between what you sell the car for and what you owe the bank will have to be taken out as a loan. Pay off the loan in full and find a new (cheaper) car that you can buy.
With this information locked in, you’ll know where you stand. Either you can afford more cars or you should replace one of your cars with a less expensive option. Having too much money tied up in cars can really stunt your financial growth.