Purchasing a vehicle is a big decision, and knowing what you can comfortably afford on a loan before you sign can be key to staying in control of your finances and saving yourself stress down the road. Financial experts recommend that a car payment be less than 10% of your current monthly take-home pay, in order to avoid financial distress. Creating a monthly budget, reviewing your credit report ahead of time, and saving for a down payment can all be very helpful when determining what you should spend on a car loan.
When creating a monthly budget, start by adding up all of your current fixed expenses. This includes rent or mortgage payments, utilities, and any other recurring monthly payments. Next, it’s important to factor in any estimated expenses, such as gas, groceries, maintenance, entertainment, or unexpected emergencies. If you do not currently have a vehicle, it’s necessary to account for the cost of insurance and registration. Browse insurance rates ahead of time to see what affect it will have on your budget. Now, subtract all of your current and estimated expenses from your take-home pay, along with any additional income you receive on a consistent basis. Ideally, your loan payment should be less than the remainder.
Secondly, review your credit report at each major consumer reporting agency: Experian, TransUnion, and Equifax. Consumers are entitled to a free copy of their report every 12 months, from each agency. Upon review, it’s important to dispute any errors you find, as any negative errors could affect the interest rate you qualify for. In addition, knowing your credit score could help you determine your potential interest rate. Keep in mind that pre-owned vehicles tend to have a higher interest rate than new vehicles. Click Here to see the average APR’s by credit score for new and used vehicles.
Lastly, decide what you can place as a down payment. Begin putting money aside to save up for a larger down payment, if you have time, as any money you put down is less you need to borrow. After determining your budget, your potential interest rate, and your down payment, you can begin calculating your ideal, and most comfortable, loan term length. Remember, shorter loan term lengths save significantly on interest over time, and your budget will thank you in the long run.