The headline that’s doing the rounds is that people spend $1000 a month on car payments. Yes, the market sucks and cars are more expensive than ever, but that doesn’t mean you have to be stuck with a four-figure car rating.
Let’s first look at why the rise in “average” payments isn’t so scary and, frankly, not so helpful. You take a large sample of monthly payments and divide by that number to get your average, which is currently sitting around $700 per month. Now you may remember that if you add a large number to your sample, your “average” will increase. For example, if we use 24, 55, 17, 87, 100, and 250, we get an average of 88.8.
There is a relationship between those $1,000 monthly payments and an increase in the average payment that many outlets miss and that is the fact that the wealthiest buyers are turning to purchase cars instead of lease them because now leasing is generally a bad idea from a mathematical point of view.
In previous markets you would have people leasing luxury cars like a BMW X5 for around $800 a month, now those people are financing those vehicles instead and looking at those four figure payments. Because it’s more common, those more expensive cars that are currently being financed skew the average payment upwards. Of course, rising interest rates and transaction prices relative to MSRP also play a role, but not to the same degree.
This brings me to the next point: that these “average” numbers are of no use to you as an individual buyer. Just because an “average” person spends $700 a month on a loan doesn’t mean it’s right for you. The advice columns will just say “don’t buy more than you can afford”, but they don’t give you the steps to figure that out.
The first step is to understand what a comfortable monthly payment looks like. There is no hard and fast formula here, some say no more than ten percent of your net monthly income, but different people have different thresholds. What buyers need to do is get an honest idea of how much money is coming in each month, how much is being spent on various expenses, and how much would be comfortable for them to spend on a car. The other factor is the amount of cash the buyer has to use as a down payment and there is a balance between maintaining your payments and having cash available.
Once you have that comfortable payment and down payment in mind, the next step is to calculate affordability. Again, we need to go back to math class and fire up this handy calculator, or in this case an online calculator that will help us budget. I use Calculator.Net and select their auto loan tool. You click on the monthly payment tab and plug in the payment that suits your budget.
You can even factor in a down payment, interest rate, local sales tax, dealer fees, and more. For this exercise, I kept it simple and targeted a payment of $400/month on a 60 month loan at 5% APR using $3,500 down payment. This gives me a total spending limit of around $24,7000. Therefore, when researching and researching potential cars, I shouldn’t look for vehicles with a sale price of more than $25,000, as these will exceed my budget.
It all sounds super simple and it is. Other “hacks” like shopping around for your rates, refinancing, and getting pre-approved are all smart steps to getting a competitive auto loan that are well worth the effort. The problem is, too many buyers get a car loan that stretches their finances and acts like it’s out of their control. The reality is that if you pay too much for a car loan, it’s probably because you didn’t do the math in the first place.
Tom McParland is a contributing writer for Jalopnik and runs AutomatchConsulting.com. It takes the hassle out of buying or renting a car. Do you have a question about buying a car? Send it to [email protected]