There is no set amount that you should spend on your first car, but there are certain factors that you should consider before buying.
How Do You Plan to Finance Your Purchase?
The biggest decision you have to make is how you’re going to pay for this purchase: cash or a loan? A loan will cost you more in the end, since you’ll have to pay your bank or lender interest, but it will also help you establish some good credit history, provided you make all of your payments on time. Cash, on the other hand, will save you hundreds of dollars, in that you won’t pay any interest, but it can be tough to come with sufficient funds to purchase a car that won’t leave you stranded on the side of the road somewhere. Let’s take a look at each mode of financing.
Lenders use a set of criteria when they are determining whether or not to approve a car loan. Many of those criteria should go into your thought process when you are deciding how much to spend on your first car, even if you intend to pay cash for it. Here are the basic criteria lenders consider.
- Loan to value (LTV)…between 85 and 115 percent.
- Age of vehicle…less than 8 years old.
- Term of loan…36 to 72 months.
- Miles on vehicle…under 100,000
- Down payment…at least 10 percent or $1,000.
- Time on job…two years.
- Time at residence…again, two years.
- Monthly income before taxes…depends on lender, usually $1,400 minimum.
- Credit score/profile…540 or above. Should have four paid as agreed lines of credit, one being an installment loan with twelve on-time payments of $150 or more.
- Total debt to income including new payment…most lenders look for less than 36 percent, but some specialty lenders may stretch that to 45 percent.
How Much to Spend if You Finance?
You do not want to commit more than fifteen percent of your monthly net (after tax) income to payments for a car loan/s. If you do, you may find it difficult to pay for other car related expenses like insurance, maintenance, or fuel.
An easy way to find out how much you can afford is make payments to your savings account. It works like this. Determine what kind of car you want, what year, etc. Look up the retail value on kbb.com or nadaguides.com. You can then take that amount over to our calculator that will give you an approximate payment for the retail value of the car you want. With that payment amount in hand, start putting that amount into your savings account on the day you would like your car payment due. After doing that for six months without needing to withdraw any of the cash, you will know that you can afford the payment and have built a nice down payment in the process. If you think you must pay cash for a car because you have bad credit or no credit, you are most likely mistaken. There are many lenders who may be willing to offer you a loan even if other lenders have turned you down.
How Much to Spend if You Pay Cash?
If you do not want to take on a loan, you can use the same process to build up your cash. Look at your current income and expenses. If you can, start putting at least $200 a month into savings. Once you have at least $1,000 saved, start looking for a car. Some personal finance experts advise spending as little as 10% of your gross annual income on a car. This is a great strategy if this will buy you a decently reliable vehicle, given your income. If your income is pretty low, you may end up going as high as 25-30% of your income, so as to afford a vehicle with fewer miles under its belt.
To conclude, if you’re buying your first car, your finances are apt to be a fairly precarious position. It is best to spend as little as you possibly can, while still obtaining a car you can depend on. Your first car should not be anything fancy or luxurious–you haven’t earned that yet. If you value your financial future, it should be utilitarian transportation that won’t leave you stranded.