What Percentage of Your Income Should Go Toward Auto Loan Payments?

What Percentage of Your Income Should Go Toward Auto Loan Payments?

Setting a monthly number

It might seem obvious, but the first step to figuring out how much you can spend on your new car is to calculate your monthly budget. Add up all your monthly income, subtract expenses (everything from rent or mortgage payments to food and healthcare), and see how much is left. For your benefit, the Federal Trade Commission even offers a sample budget sheet online.

But don’t dedicate every last penny of disposable income to a car. Instead, experts have developed some guiding rules for how much is reasonable to spend.

In the past, advisers sometimes recommended what was called the 20/4/10 rule: make a 20% down payment, have a loan lasting no longer than four years and don’t let payments exceed 10% of your gross income. But those figures aren’t realistic for today’s shoppers. In part that’s because car loans last much longer: In March 2020, the average auto loan surpassed 70 months, according to Edmunds research.

Today, experts generally recommend spending no more than 15% of your monthly take-home pay (that’s how much you receive after taxes and other deductions). Depending on your budget, spending closer to 10% might be a more reasonable guideline.

Based on those rules, somebody with a take-home income of $3,000 per month might consider a payment of $300 to $450 per month, figures that represent 10% and 15% of their take-home pay, respectively. If you’re not looking at a fancy SUV or pickup truck, that’s generally a good number when shopping for more affordable new cars.

However, it’s important to note that you’re responsible for more than just the car payment. Factor in insurance costs, too, when figuring out your total monthly car expenditure. Don’t let the combined cost of insurance and the car’s payment exceed the rule you’ve set for yourself, whether that’s 15% or some other value. For that reason, picking a base car payment closer to 10% to 15% of your take-home income is a safer rule to ensure you won’t blow your budget.

For this reason, many advisers instead recommend setting a limit for how much your total car expenses will be per month. For instance, you might decide to spend no more than 15% of your total take-home pay on your loan payment, insurance and gas costs combined. That can be an especially important rule for buyers who already have other debts.

Your monthly payment can vary significantly depe

Your monthly payment can vary significantly depending on your credit score, the length of your loan and the size of your down payment.



What we dislike about the 36% rule

As with so many car finance guidelines, there is no objective reason, why the exact number should be 36%. Sure, it’s a rule of thumb, but where does it come from? Why are 35% okay, but 37% are considered too much?

Also, if you really think about it, 36% are actually quite a lot. In the USA, these high constant levels of debt are quite normal. In the UK, they’re not and for a reason: The higher your debt level, the lower your immunity to sudden financial shocks.

Ultimately, the 36% rule is not bad. But is may just be a tad too lenient on the overall debt level.

Variation #2: The 15/22/36% rule

We mentioned before that the 15% rule is anything but ideal. A way to get around the issues is to combine and add to the 15% and the 36% rules:

  • Keep the car loan repayment costs to a maximum of 15% of your net income.
  • Keep your total car costs to a maximum of 15% of your net income.
  • And keep your total debt repayment costs below 36%.

This way, you’re getting both a very precise and a very comprehensive indication of how much of your income should go towards your car. The 15/22/36% rule is one of the greatest tools at your disposal to arrive at a sensible budget decision for your new or second-hand car.

But there’s even more.

7. Fuel

If you commute to school or work, gas is another expense to add to your budget. According to a report from the Bureau of Labor Statistics, in 2019, the average person spent $2,094 per year on gas, or about $175 per month. However, if you have a lengthy commute or enjoy road trips, then your actual cost may be much higher. To add money back to your budget, buy a car with a smaller motor that burns less fuel.

How Much Should I Pay?

The exact amount that you should spend on a car might change depending on who you ask. Some experts recommend that car-buyers follow the 36% rule associated with the debt-to-income ratio (DTI). Your DTI represents the percentage of your monthly gross income that’s used to pay off debts. According to the 36% rule, it isn’t wise to spend more than 36% of your income on loan payments, including car payments.

Another rule of thumb says that drivers should spend no more than 15% of their monthly take-home pay on car expenses. So under that guideline, if your net pay is $3,500 a month, it’s best to avoid spending more than $525 on car costs.

That 15% cap, however, only applies to consumers who aren’t paying off any loans besides a mortgage. Since most Americans have some other form of debt – whether it’s credit card debt or student loans that they need to pay off – that rule isn’t so useful. As a result, other financial advisors suggest that car buyers refrain from purchasing vehicles that cost more than half of their annual salaries. That means that if you’re making $50,000 a year, it isn’t a good idea to buy a car that costs more than $25,000.

4. Taxes and Fees

When you buy a car, the purchase price is only part of your total layout. You’ll also pay fees—and, in most states, taxes—including: 

  • Sales tax: If your state charges sales tax, then you’ll pay that on the purchase price minus any discounts and trade-in allowances. A handful of states don’t tax car sales.
  • Registration fee: You must register your vehicle. Registration fees can range from $30 to $50. 
  • Tag and title fee: You will have to pay for the title and license plates for your vehicle. 
  • Documentation fee or dealer fee: In some states, documentation or dealer fees are common. These fees are in addition to the other costs and vary by location. 

To demonstrate how those expenses can add to your total cost, consider an example. If you bought a $30,000 car in Florida, then you also would pay the following: 

  • Sales tax: $1,800 (6% sales tax)
  • Initial registration fee: $225
  • New title fee: $77.25
  • Original license plate fee: $28
  • Dealer fee: $399 (varies by location)
  • TOTAL: $2,529.25

How much money should you spend on a car based on your salary?

The rule of thumb among many car-buying experts dictates that your car payment should total no more than 15% of your monthly net income, sometimes called your take-home pay (some might stretch this to 20%, but 15% is more conservative and therefore likely to make budgeting even easier). Your net income is the money you take home after federal, state and local income taxes have been deducted from your paycheck.

Note that this 15% is meant to cover just your car loan payment, and not ongoing car-related expenses like fuel, maintenance and insurance.

The idea behind the so-called 15% rule is that if you limit your monthly car loan payment — sometimes called a car note — to 15% or less of your net income, you’ll have enough money left over each month to cover the rest of life’s expenses, including the occasional financial curveball.

Keep Other Costs in Mind

Car ownership involves more than just the monthly cost of the loan. When figuring out how much car you can afford, take into account your insurance payments and fuel costs and allow some money in your budget for basic maintenance. If your commute involves a lot of tolls, factor them in as well.


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The Takeaway

How much should you spend on a car? Only you can decide that after reviewing your budget and figuring out if you can pay for the various expenses that go along with owning a car.

Keep in mind that getting a new or used car will likely involve taking on more debt. If you can’t make at least minimum payments on the debt you already have, it might be a good idea to get a part-time job or concentrate on saving so you won’t have to take out a huge loan.

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Photo credit: ©iStock.com/Eva Katalin Kondoros, ©iStock.com/michaeljung, ©iStock.com/Antonio_Diaz


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