So you’ve got an idea of what you want, but how do you figure out your budget? There are a few different ways to do this, but the most important thing to remember is that once you set a budget, you should stick to it. If you take the time to figure out what’s affordable, it would be a waste to ignore it.
Here are some different methods for figuring out your budget (If you like, you can skip all this reading and just get pre-qualified now, but what’s the fun in that?):
1. Are you paying cash, or do you want to finance?
If you’re paying cash, it should be simple for you to figure out what you can afford — just make sure to leave yourself enough cash for emergencies. If you’re financing, the first step is to figure out how much of a monthly payment is affordable. The quickest (5 minutes or less), and easiest way to do this is to grab a pen, a blank sheet of paper, your last pay stub, and a calculator. Go ahead — we’ll wait for you. Got it? OK.
Now, start writing down your monthly expenses in a column from top to bottom. Make sure you include rent/mortgage, other car payments (if you have another car), student loans, home equity loans, 2nd mortgages, etc. These are all of your big, fixed expenses. Don’t include your current car payment — leave it off the page. Next you should write down child care expenses, credit card payments, cable, phone, utilities, and any other regular monthly bills. You also need to write down your monthly food, entertainment, and other expenses. If you don’t know how much these are, you should go through your checkbook or online bank statement and add them up from the last full month. Finally, make sure you write down how much money you want to save every month, as well as how much you want to use for making extra payments to pay bills off early.
Once you’ve written it all down, add it up. Compare the total to your monthly income after taxes — if you’re not sure how much that is, you can figure it out from your pay stub. Subtract your expenses from your monthly income and you end up with the most payment that you can afford. (If it’s is a negative number, you either did the math wrong or you spend more than you make each month.)
2. How banks figure out how much payment you can afford.
Most banks don’t have any idea what your expenses are, so they use an average to figure out what you can afford. To figure it out like a bank would, you take your gross monthly income (that’s the amount of money you get paid before taxes), and multiply it by 15%(you can use our Payment To Income Budget Calculator and skip the rest of this explanation if you want to). According to just about every bank in the US, that amount is the most you can afford to spend each month on all of your cars combined. So, for example, let’s say you earn $3k a month before taxes. 15% of $3k, is $450 dollars. According to most banks, the most you can afford to pay for a car is $450 a month. Keep in mind that number includes all your car payments, so if you have a motorcycle, an ATV, a boat, etc., the amount of that payment is subtracted from the total. This method, called the payment to income method, is a good way to figure out the most you can afford. However, method one is still the best way to make sure you get it right. If you take the time to figure out your budget now you’ll be happy in the long run.
3. How to figure out how much you can afford to finance.
Using the smaller number from methods 1 and 2, you should come up with your ideal monthly payment. Once you know how much of a monthly payment you can afford, it’s pretty ease to figure out how expensive of a car you can afford to buy (you can use our Price Range Calculator and skip the rest of this explanation if you want to). Take the amount of your ideal monthly payment, and using your calculator, divide it by 25. Then, multiply by 1000. That amount is the bottom end of your spending range. Now, clear the calculator and repeat the same step, but this time divide the ideal monthly payment by 20 (instead of 25). That’s the top end of your spending range. For instance, a $300 ideal payment gives you a spending range of $12-$15k dollars. You should only look at vehicles with an asking price of $15k or less if you want your payment to be $300 a month. As long as your credit is good and your sales tax is normal, this method works pretty well. Of course, the easiest way to figure all this out is to…
4. Get Pre-Qualified.
We can’t emphasize this one enough — regardless of your credit situation, regardless of your financial circumstance, there’s absolutely no good reason NOT to get pre-qualified. You can call your bank, your credit union, or you can use our recommended online quote services to find out what you can afford, what interest rate you’ll get, etc. We suggest everyone get pre-qualified as early in the process as possible. This way, you won’t waste time looking at the wrong vehicles, and you don’t have to feel nervous about your financing while you shop. Filling out an online quote form is easy and fast, and we highly recommend it. If you don’t want to do it online, call your local credit union or your local bank. They have people their that will ask you some questions, check your credit, and give you a good estimate. Going online is the fastest method, and you can also get multiple quotes online fairly quickly. Calling multiple banks on the phone takes much longer.