Americans have a love affair with their cars. According to a recent CNBC report, about 78% of people live paycheck to paycheck. And yet most of them have two new cars in the garage. So how much should be budgeted for a car payment? Here are three plans that will help keep your car budget on track.
Budget-based
Financial expert Dave Ramsey says that monthly automotive expenses should not exceed 10% of your monthly take-home pay. If your net pay is $5000, he says you can spend $500 a month. But that’s not just the car payment. This includes payment, insurance, inspection, registration, repairs, and maintenance. For most people netting $5000 per month, that might be a $375 to $425 car payment.
Income-based
Dave Ramsey also says that stuff with engines should not exceed half your gross income. The individual with $5000 net pay may gross $7000, or about $84000 annual income. That means stuff with engines should not exceed $42000 to $43000.
NOTE: Stuff with engines can include cars, RVs, motorcycles, boats, jet skis, snowmobiles, etc.
The 20/4/10 Rule
Put 20% down on any car you purchase, new or used.
Finance it for no more than 4 years.
The payment and expenses (payment, insurance, inspection, registration, repairs, maintenance) should not exceed 10% of your gross income.
If your purchase meets these criteria, you will reduce the likelihood of experiencing financial trouble.
Think Different
Cars go down in value, especially new ones. A new car loses about 25% of its value the instant you drive it off the lot. After 4 years, a new cars will be worth about 30% of its purchase price.
Would you purposely invest in a stock that you knew was going to lose one-fourth of it value right after you bought it? And was going to lose 70% of its value within 4 years? Probably not.
So why do we buy new cars?
Try something different. Buy a used car. We found a one-year for 25% less than the MSRP. And it looks just as nice and drives just as nice as a brand, spanking new one! We just let the first owner take the depreciation hit.
Keeping Your Eye on the Ball
Why should you limit your car expenses? The less you spend on a car, the more you have to build wealth. In The Millionaire Next Door, the authors explain that most Prodigious Accumulators of Wealth (PAWs) buy used cars. By not overspending on depreciating assets, PAWs are able to accumulate wealth, retire with dignity, and to change their family tree.
Are you ready to think differently?