Auto Financing Guide
Purchasing a car can be overwhelming when you have no clue where to start financially. The key to a successful vehicle purchase is figuring out what you can manage financially while still finding a car that checks all of your boxes for a perfect ride.
Experts usually recommend spending only 15% of your monthly wages on the vehicle itself and only 20% on the acquisition, which comprises your insurance, fuel, car payments, and more. Determining affordability requires a balance between meeting your car needs and staying within your budget.
What is Affordability?
We’d all love to have a car with the most luxurious interior and exterior features, but it doesn’t always agree with our finances. The most important thing is to afford your monthly payments when purchasing a vehicle.
Regardless of whether you purchase new or used, you’ll have to budget for insurance, maintenance, and other expenses and make sure they all fit into your monthly budget. You can use our car affordability calculator to help you budget auto costs. With how much you can afford, here are some factors that will influence the price of your vehicle:
• Down Payment — The more you can put down, the less your monthly expenses.
• Credit Score — The higher your score, the better your interest rates and the more money you can save.
• Sales Tax — In Cleveland Heights, it’s 8%, but it varies from state to state.
• Loan Term — The shorter the loan term, the faster you pay off your loan. However, your monthly payments will be more significant since you’re paying the amount over a shorter amount of time.
• Interest Rate — The lower your interest rate, the less you will spend, and ideally, the more car you can afford.
How to Determine How Much You Can Afford
Let’s go over the key steps:
Calculate the Car Payment You Can Afford
Instead of getting to the auto dealership to find out you can’t afford the payments for your dream car, you can use one of our online calculators to help determine what you can afford. The online calculator can help if you know the price of your vehicle and need to estimate the monthly payment. If you know the monthly payment you can afford, you can use it to calculate the vehicle price to see the range you should look for.
Our online calculators work based on factors such as vehicle price, monthly payment, down payment, trade-in value, term, interest rate, and sales tax. Key in all the information and hit search.
Calculate the Car Loan Amount You Can Afford
Now that you’ve calculated your affordable monthly payment amount, you can get an idea of how much you can borrow. This depends on a few other factors, including:
• Credit Score — This will partly determine your annual percentage rate on the loan.
• Loan Term — How many months do you have to pay off the loan?
Set a Target Buying Price
The total loan amount you can afford is not necessarily the price of the vehicle you can afford. If you’re trading in your old vehicle or making a down payment, you can borrow less or get a higher-priced car.
Keep in mind that there will be sales tax and fees, so think about more than just the price on the window sticker. Once you determine the car loan amount you can afford with no down payment or trade-in credit, you can get a more realistic idea of the buying price you should consider.
You’ll need to consider sales tax and fees, which differ by state, to the advertised cost of the vehicle to get your total car price. An easy way to calculate these extra costs is to add 10% to the displayed price of the automobile.
For example, if you can afford a $25,000 auto loan with no trade-in credit or down payment, you’ll want to shop for a vehicle with a sticker price of around $23,000 so that you’ll be able to cover sales tax and fees with your total loan amount.
Budgeting for Additional Car Expenses
Once you estimate the car, you can afford it based on your salary. It’s essential to list other costs of owning a car. You’ll want to consider additional living costs such as savings, groceries, rent, and more when deciding how much you can afford to spend on a vehicle. Another thing that you will want to include is a buffer for additional car expenses. Here are some additional costs to factor in as you create your budget:
• Routine Maintenance — Over time, our cars need a tuneup. Whether it’s regular washes, tire rotation, or oil change, make sure you allocate some of your budgets to these expenses.
• Gas — Don’t forget to include your monthly gas expenses in your budget.
• Emergency, Savings, and Repairs — If you’re able to, it’s an excellent idea to save for emergency repairs, even if it’s a small amount per month.
• Additional Warranties — Some dealers may offer extended warranties, which can increase the total price of the vehicle.
• Add-Ons — Frequently, the advertised car is the base model with basic features. If you want special features, you’re probably looking at a price increase.
Other Factors That Affect How Much You Can Afford
If you already own a car, you can trade it in. Your trade-in value can apply to purchasing your next vehicle, lowering the loan amount.
When you trade in your old ride, the dealership purchases the car from you. But instead of handing you a check, they’re putting that money toward the acquisition of your next ride. This allows you to take out a smaller loan, saving you money.
Car Sales Tax
You’ll probably have to pay sales tax when you purchase an automobile. Your state sales tax rate on vehicle purchases should be easy to find. Sales taxes are typically 5% to 10% and might include local, county, and state taxes. The sales tax is added to your auto loan, increasing the amount you owe. Regrettably, this amount is not negotiable, so you must pay it.
In Cleveland Heights, sales tax is 8%. This includes Ohio’s sales tax of 5.75% and Cuyahoga County’s sales tax of 2.25%.
Car Loan Interest Rate
The price of a vehicle isn’t the only thing that dictates how much you can afford. The interest rate on your auto loan also influences your monthly payment. A lower interest rate means a more down payment. However, not everybody qualifies for a low rate.
The most critical factor in determining your interest rate is your credit score. Individuals with a high credit score get lower interest rates because they’re seen as being at low risk for not paying their auto loan back.
Look at your credit score and current interest rates to estimate the interest rate you might get. You can still get an auto loan with bad credit, but it might take some extra steps.
Three Rules of Vehicle Financing
Put at Least 20% Down
If you can, make a down payment that is 20% of the price of the vehicle you’re purchasing. A down payment is a lump sum payment you make at the start of your auto loan. It helps reduce your monthly payments and ensures you have equity in your next car straight away.
While you can take out an auto loan with no money down, you’ll be upside down on your loan for a while. Being upside down on a loan implies you owe more than the vehicle is worth. This is because new cars depreciate about 20% once they’re sold. Putting 20% down keeps you from owing more than your car is worth.
Auto Loan Terms Shouldn’t Exceed Four Years
The more extended your loan term, the longer you’ll have to meet your lender’s insurance needs, resulting in higher rates. By the end of four years, your vehicle will have lost most of its value, and you won’t want to be still paying it off. Four years is the maximum most finance experts recommend. If you can pay off your vehicle in three years, that’s even better.
Car Payments Shouldn’t Exceed 10% of Your Gross Income
Your dream vehicle isn’t worth having if your monthly payments leave no wiggle room in your budget. Staying below 10% means you’ll have money to set aside for other things such as a nice vacation, a down payment on a house, or an emergency fund.
Total Costs for Owning a Car
Last, when you’re thinking about purchasing an automobile, don’t forget that apart from the cost of acquisition, owning a car also incurs other overlooked costs such as:
• Auto insurance
To determine the actual cost of owning a car, we can use some statistics:
United States Department of Labor (Bureau of Labor Statistics), in their 2017 Consumer Expenditures report, declares that the average cost of owning and operating a vehicle is almost $9,576 per year. $4,054 out of this amount is the purchase cost (leasing payments, averaged yearly depreciation costs, Etc.), $1,968 is the cost of motor oil and gas, and $3,554 accounts for other expenses.
According to American Automobile Association, the average year-long cost of owning an automobile is $8,849. This cost covers auto loan interest, depreciation costs, registration, maintenance insurance, and gas.
Essential Tips When Buying a Car
While the reviewed guidelines make it possible to calculate how much car you can afford, that doesn’t imply that figure should be your actual budget. If you want more freedom in your monthly expenses, try to spend less on a car than you can afford to pay.
Shop Around for Controllable Expenses
While you cannot control the cost of license plates or taxes for your vehicle, you can shop around for the most affordable car insurance rates. The price of your auto insurance policy can differ by a considerable amount depending on the agency you purchase from. You can ensure you’re getting the best likely deal by comparing policies and fees.
Look at Used Cars Instead of New Ones
New cars depreciate quickly from the moment you drive them off the lot, and they continue to do so. The same thing happens with used vehicles, but you can at least dodge the initial drop that comes in the first couple of years.
Don’t Forget Additional Costs
Besides the price of your purchased vehicle, you’ll have to pay for any additional taxes, insurance, and license plates levied by your state. You will also have to plan for sales tax on your vehicle.
Allow Some Room in Your Monthly Budget
If you’ve already worked out a budget with the help of our online calculators and guidelines, you probably know how much you can afford to pay for an automobile every month. Remember to leave plenty of wiggle room in your budget. Life happens, and unexpected expenses can pop up.
Stick to a Budget
This may seem obvious, but it’s vital. If you’ve gone through the trouble of placing a limit on how much you can spend on a vehicle, make sure you stick to it.
Shopping for a vehicle is exciting, but be realistic with your budget to avoid overspending. A car isn’t worth purchasing if you can’t afford monthly payments or the general upkeep. Once you’ve calculated the cost of an automobile in your budget, it’s time to secure a car loan and shop for your ride. Our in-house auto financing at Honda of Cleveland Heights helps drivers get into reliable cars at affordable rates, so contact us if you’ve any questions.