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One of the first steps you should take when you are considering buying or leasing a new or used vehicle is figuring out how much you should spend on the car. That’s not how much you “can” spend on a car, but how much you “should” spend.

Cars, whether they are new or pre-owned, are expensive to buy and operate – and they’re only getting more costly. On top of that, interest rates are slowly creeping up, making the cost of auto loans and leasing more expensive.

Average used car prices topped $20,000 in late 2018, according to Edmunds, while the average new car transaction price was higher than $37,000 in January 2019, according to Kelley Blue Book. Along with higher car prices, car loan balances and average loan lengths have grown to more than five and a half years, with a growing number of cars now financed for seven or eight years.

It is important to remember that buying a car is not an investment. It is a massive expense for a rapidly depreciating asset. You can expect a new vehicle to lose as much as a third of its value in the first year of ownership. Most buyers finance the purchase of a vehicle with a car loan, which is a legally binding contract that you can't just walk away from without tremendous damage to your credit score. You can learn more about car loans by reading our guide to How to Finance a Car and Get a Car Loan.

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So, How Much Should You Spend on a Car?

Many buyers first decide on the car they want and let that dictate a monthly car payment, or they let a car dealer help them determine how much they can afford. Both are horrible ways to decide how much you should be paying. By playing with the numbers, a skilled salesperson can craft a car loan that has you paying too much for a vehicle over the life of the loan.

Instead, you want to figure out what monthly payment fits into your budget, then determine how much car you can buy with a reasonable loan length. The longer the loan you take, the more you will pay in total for the vehicle, and the more financial risk you’ll expose yourself to. It is critical that you look beyond the cost of the car itself, and include the costs of car ownership, such as insurance, gas, and maintenance in your budgeting.

Different experts have varying ideas of how to best determine your car-buying budget. We’ll look at a few popular methods for determining how much you should spend:

No More Than 15 Percent of Your Monthly Take-Home Pay

Some experts suggest consumers whose only debt is a mortgage can allot 15 percent of their take-home pay for a car. The average American household income at the end of 2017 was $60,336, according to the U.S. Census Bureau. On average, 29.8 percent of that went to taxes, leaving $42,356 in after-tax pay. Multiply the total take-home pay by 15 percent, and you'll have an annual car budget of $6,353. That works out to $529 per month. Of course, your net take-home will likely be a little less after you pay something toward your health insurance and retirement plan.

You might be thinking you can afford a lot of car for $529 per month, but there’s another part to the 15 percent rule. It says that your total auto budget, including fuel, insurance, and maintenance should not exceed 22 percent of your take-home pay. That makes your total monthly budget in this example $777.

The average price of car insurance, based on the top 10 insurers in the country, is $3,953 per year, or about $329 per month. Figure another $100 or so per month in fuel and maintenance costs, and your total monthly car budget is reduced to $348.

We can plug that $348 per month into a car affordability calculator to see the cost of the vehicle you can afford. We’ll assume you can get a 5 percent loan for five years and make a $2,000 down payment. In this example, with a $348 monthly budget you can afford a car that costs $19,655. For that price, you’re able to buy a variety of compact and midsize new vehicles and a few subcompact SUVs. It’s enough to afford a used midsize SUV that’s a couple years old.

If you are able to find a great lease deal, you can opt for leasing a new car instead of buying. There are frequently a number of midsize SUVs available on our lease deals page with monthly payments that would fit your monthly budget. Before you think about leasing, though, be sure to read our article on the differences between buying and leasing.

Given the price of cars today, this vehicle affordability model might seem very conservative, and it is. It does, however, ensure you don’t get in over your head – with your car payment dominating your monthly budget. Unfortunately, if you have dings on your credit report or driving record, you’ll have an even lower car buying budget, as your auto insurance cost and auto loan interest rates will be higher.

Half Your Annual Salary

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Another set of auto-buying experts suggests your car-buying budget can be as high as half of your gross yearly income. That would suggest someone with the U.S. median income of $60,336 could afford a car costing $30,168. That’s enough to buy a nice car or SUV at a new car dealer or even a second-hand luxury car.

Unfortunately, when you dig into the numbers, the idea of buying that much car isn’t a great idea in the long run. Using a car loan calculator, we can determine that a $30,168 used or new car with a 5 percent car loan for five years with $3,000 down and 4 percent sales tax would have monthly payments of $535. We’ll conservatively estimate an additional $400 per month for insurance, fuel, and maintenance, so now you’re looking at $935 per month. If we use the same amount of take-home pay as the example above ($42,356 per year, or $3,529 per month), your car will consume 26 percent of your budget – and that’s only if you have good credit and an unblemished driving record.

36 Percent of Your Income Devoted to Debt Payment

The next method of determining how much you should spend on a car takes a deeper dive into your personal finances to come up with a budget. It says that no more than 36 percent of your gross income should be devoted to paying all of your debts, including your mortgage (or rent), student loans, auto financing, and credit card debt.

Let’s look at the household with the $60,366 in annual income again. Broken down, that’s $5,028 per month. The 36 percent method says that a maximum of $1,810 should be devoted to all of the household’s debt. The most recent data from the U.S. Census Bureau show the average monthly mortgage payment runs $1,030, though that number is from 2015 so today’s average is likely higher. Apartment rents in America averaged $1,419 in 2018, according to industry analyst firm Yardi Matrix.

Using this model, a homeowner with an average mortgage can afford a monthly auto budget of $780, while a renter could only afford a car budget of $391. If you are like many Americans, however, and have student loans or credit card debt, the amount under the 36 percent debt cap that you can devote to a car can quickly evaporate. Note this model only looks at car loan debt, not the total cost of owning a car.

Lenders use the 36 percent rule when approving and setting the terms for car loans. If you exceed a debt-to-income ratio of 36 percent, you’re less likely to be approved for a loan. Any loan you do get with a debt-to-income ratio exceeding 36 percent will likely come with an interest rate that is higher than average.

The 20/4/10 Rule

One of the old rules of car-buying was that you could afford a car, truck, or SUV with a 20 percent down payment, a four-year auto loan, and no more than 10 percent of your annual gross income used for car payments. Given that cars are more expensive and powertrain warranties are five years or more on many new models, we’re going to revise the rule to allow a five-year car loan.

Using the average annual income, sales tax rate, and the five percent interest rate from our other examples, we can compute that you can devote as much as $502 per month to a car payment. It takes a little trial and error with a car affordability calculator to determine the amount you can afford with a 10 percent down payment, but in this example it works out to $28,299 with a down payment of $2,830. That’s about enough for a well-equipped compact SUV or the base model of a minivan.

A Trial Period of Making Payments to Yourself

The above methods for determining how much you should spend on a car give us results ranging from $348 to $535 with the same gross salary. That’s a pretty big difference in affordability, and it could vary even more if you have to pay a higher interest rate on your financing or your car insurance costs more than average.

You can get a better idea of how much you can afford by actually making payments to yourself for a few months before you commit to an auto loan. Instead of paying $400 to your bank or credit union each month, for example, make a car payment to yourself by setting the money aside and not spending it. After doing so for three months, you’ll have a good idea of how the payment fits in your budget. If it doesn’t allow enough cash left over to meet your other obligations, you’ll need to look for a less expensive vehicle. A great side benefit of this strategy is you’ll have the cash you saved to put toward your down payment.

Other Factors to Consider

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While the above rules can get you into the ballpark of how much your budget will allow you to spend on a car, there are a few other things you should consider when setting an auto purchase or lease budget.

Know Your Expenses / Subscription Services

Many consumers today have monthly expenses that go beyond traditional utilities, rent, and loan payments. While that Netflix subscription, satellite radio, Pandora plan, cell phone purchase installment, and other monthly fees might seem small on their own, they can total up to take a good-sized dent out of your budget. If you commute using public transportation, that expense alone can cost well over $100 per month. Add an expensive cell phone data plan and cable TV subscription, and you’re talking about taking serious money out of your monthly budget.

Multi-Car Households

The above examples assume that the household only has one car. In families needing more than one car, you'll have to split the car-buying budget among all the vehicles. Even if a vehicle is paid off, it will still have fuel, insurance, and maintenance expenses that need to be figured into your budget. On the bright side, most many auto insurance companies offer multi-car discounts.

Consider Your Future Spending

When planning your budget, it is important to consider events in the future that will give you either more cash each month to spend on a car or less. If you’re planning on buying a house (with a mortgage), for example, think about the total of your car payment and house payment will affect your debt to income ratio. If retirement is on the horizon, consider how a vehicle will fit within your level of retirement income.

How Do You Use Your Budget?

The first question most car salespeople will ask when you arrive at the dealership is "how much are you looking to spend per month?" You never want to give them the figure you have in mind as your monthly budget. Many sales professionals will structure a deal that uses every penny of your max budget (or more) while maximizing dealer profit. Often, they'll do so by putting you in a financing plan that has you paying for the car for six or more years.

Instead, you want to focus on the total price of the car, including the financing. Take your own calculator with you so you can run the numbers yourself on any deal you are offered. Always remember that buying a car based on monthly car payment alone is a potentially costly way to buy, in the long run.

How Can You Stretch Your Car-Buying or Leasing Budget?

You may have noticed from the examples above that the percentage of your income that you can devote to a used or new vehicle is lower than you thought. There are several ways to improve how much car you can buy without your car payment exceeding a safe percentage of your earnings.

Get Affordable Financing

The best two ways to lower the total cost of a car purchase are to reduce the price you pay for the vehicle and lower the price you pay for your loan. Our guide to How to Negotiate the Price of a Car will help you with the first one, and getting a great interest rate on your financing will help with the second part.

A key to getting the best financing deal is to have pre-approved financing in place before you visit the dealer. While most buyers have their financing arranged by the dealership, not having a pre-approved auto loan can cost you thousands of dollars in extra interest. Simply put, if you haven’t shopped around for a low-interest loan, the dealer will have no benchmark to beat. They can offer you a loan that gives them the most profit, rather than one that gives you the highest savings.

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You should visit the websites of several local banks, credit unions, and other financial institutions, and apply at more than one to see who can give you the best deal. U.S. News Partner myAutoloan can get you up to four offers with one simple online application. Most lenders will get you a preapproval up to a certain amount, so you have some flexibility in what you buy. Of course, you never want to tell a salesperson what that amount is.

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Automakers frequently offer new car purchase incentives on slower-selling models or those that are due for a redesign. By taking advantage of a car deal, you can get a lower price, less expensive financing, or both. Our new car deals page shows the best incentives car manufacturers are currently offering.

Consider Leasing

When you lease a car, you only pay for the amount of depreciation expected to occur during the length of the contract, rather than the full purchase price of the vehicle. Though you won't actually own the car you are driving, your monthly payments will generally be much lower with a lease.

Read our article on Leasing versus Buying to learn more about the pros and cons of leasing a vehicle.

Look at Certified Pre-Owned

New cars are great, but they come with high price tags. Used cars are much more affordable, but they don't typically come with warranty coverage. In between are factory-certified used cars (CPO cars). They're gently used cars that are usually just a few years old, have low mileage and no history of accidents, plus come with warranty coverage.

They cost less than equivalent new cars, but more than non-certified used models. Explore our article on the Pros and Cons of Certified Pre-Owned cars to learn more.

Make a Bigger Down Payment

Every dollar that you add to your down payment is one less dollar you have to finance and pay interest on for years. By reducing your loan amount, you’ll reduce your car payments. Get your loan amount down far enough, and you might qualify for a lower interest rate or be able to pay it off with a shorter loan term.

There are a couple of ways to increase the amount of money you have for a down payment. You can save for a few months before you get into the market or you can increase the amount of money you get for your trade-in by selling the car yourself. Typically, you won’t get as much money when you trade your old car in at a dealer as you will by selling it yourself to another dealer or a private party.

Improve Your Credit Score

Having a good credit score helps your monthly car-buying budget in two ways. First, buyers with lower scores have to pay considerably higher interest rates on their financing. Buyers with worse credit can pay three or more times the rate that borrowers with excellent credit qualify for.

It’s a good idea to look at your credit scores well before your car-buying process begins. Many credit cards offer a peek at your scores as a benefit of having the card. You can also go to sites such as CreditKarma, who will provide your score in exchange for giving them some personal information. You are entitled to see the credit reports behind the scores for free once each year. The website AnnualCreditReport.com is your gateway to reports from the Equifax, Experian, and TransUnion credit reporting bureaus.

In most states, auto insurance companies use your credit score when deciding on the rates you pay. Because they can demonstrate that customers with lower scores have a higher incidence of claims, it is legal to charge higher insurance rates to those with challenged credit. Our article on Car Insurance Discounts can help you find the price breaks you qualify for when buying auto policies.

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Buying a new or used car is much easier when you have knowledge on your side. The experts at U.S. News & World Report are on your side, providing the research and information to shop confidently. Our new car rankings and reviews are based on the consensus opinion of the nation’s premier automotive journalists, linked with quantitative data on safety and predicted reliability. Our used car rankings and reviews add the cost of ownership into the research equation to help ensure an affordable ownership experience.

Our staff scours the market to find the best purchase and lease incentives available. Visit our new car deals page to find the best low-interest and cash back offers from automakers. Buyers in the used car market can find special financing offers on CPO cars by visiting our used car deals page. If you’re looking for a lease, our lease deals page shows hundreds of special lease offers with low monthly payments and little due at signing.

Getting an affordable financing deal can save you big money over the course of a car loan. U.S. News partner myAutoloan works with lenders to find you savings. They make it easy by getting you up to four offers with just one online application.

The U.S. News Best Price Program works to lower car prices by finding prenegotiated deals with local dealers. On average, buyers save more than $3,000 off MSRP when they use the program.