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Determining How Much Car You Can Afford

Things to Consider Before Buying a Car

The first step you should take when planning to buy a car is to determine how much car you can afford.  Many of us tend to compute how much money we have left after paying our housing and other expenses and use this as a starting point.  However, making a decision on such little information is probably not the right choice.  So before you make your decision about how much car to buy, take these other factors into account.

Will you still be able to meet your savings goals?  Saving money for an emergency fund or to invest toward your retirement should always take precedence over spending money on a car. Unless you will be able to save at least 10% of your income each year, you shouldn't spend any more on a car than you have to.

What effect will it have on your debt ratios?  Debt ratios are used by almost anyone that extends you credit.  Whether you want to buy a home, another car, or take out a business loan or new credit card, the company extending you credit will want to look at your debt ratios and your credit report.  Having an installment loan will always lower your ratios and make you a higher risk for credit.  With that said, having an installment loan will also help build your credit.  Think about these factors before making your car buying decision.  If you are planning to buy a house or take out a loan during the life of your car payment, you're going to want to minimize the amount of money you spend on a car.

Know how much the payments will be.  It's easier to calculate how much you can pay on a monthly basis than to calculate the total price of the car you can afford.  Use the information above and create a budget for yourself to see how the payment would affect your lifestyle and savings plan.  Then, you can use a car loan calculator to help you calculate how much car you can afford.  Make sure you check with your local banks and car dealers to find a realistic interest rate to plug into the car loan calculator.

Don't underestimate the "other" costs of buying a car.  A car is a big purchase, but there are many other cost that go along with the purchase.  It is typical for additional car purchase costs to reach 10-20% of the purchase price.  In some cases, taxes alone can be close to 10%.  Then there are all the service fees, loan fees, car options, undercoatings, protection plans, warranties, etc.  In addition, you should plan on paying more for your car insurance with a new car.  And don't forget about the annual licensing fees and registration costs.

While this list isn't exhaustive, it can hopefully help you look at your car buying decision with a little more scrutiny and thought than many of us do.  Good luck with your purchase!