Several analysts have reported that car sales are expected to rise this year, in part because there’s a sizeable group of people who need to replace their older vehicles. But how much is the “right” amount to spend?
If you’re looking to finance, you might consider the 20-4-10 rule: 20 percent down; financing that lasts no longer than four years; and principal, interest and insurance that doesn’t exceed 10 percent of your gross household income.
It’s a formula that can help change the way we think about how we define the affordability of a car, and potentially start to free up some extra cash for other, more important financial needs such as retirement or even the more basic emergency savings fund.
“How that change in thinking lowers your stress level is just amazing,” says Mike Sante, a managing editor at Interest.com, which recently completed a study that looked at car affordability. “It can make a tremendous change in your quality of life. This is where the money is for your savings.”
Americans are largely spending too much on cars, an asset that is often our second-largest household expense after rent or a mortgage and offers no potential for increasing net worth. For example, taking into account car insurance costs and the Boston area’s median income of almost $70,000 a year, Interest.com calculated that a typical Boston household can afford to spend up to $26,025 on a car. It would take a pretty good amount of self-control to avoid spending more than that, since the average new car with bells and whistles costs $30,550.
“When you talk about a market like Boston, where housing and the cost of living is expensive, [the one area] where you have control over how much you pay is for a car,” Sante says. “This is where your flexibility is, and where what you do can free up money and suddenly make possible some of those things that you’ve always said you want to do.”
The need to start re-thinking some of these bigger expenses is made even more evident by a recent study by Bankrate.com, which found that only 55 percent of Americans have more emergency savings than credit-card debt.
“Save more of that money,” implores Sante. “Keep it and invest in yourself.”
Boston ranked third among 25 major cities in the car affordability study by Interest.com. Topping the list was Washington, D.C., with an affordable purchase price of $31,940. San Francisco ranked second at $26,786.
For each metro area, Interest.com calculated 10% of the monthly median gross household income in that area and subtracted the average monthly insurance premium in that area to determine the maximum amount that the median-income household should spend on monthly car payments (principal and interest).
Interest.com used its Auto Loan Calculator to calculate how much the median-income household can afford to borrow. Assumptions: 20% down payment, 48-month loan, national average interest rate, roll the sales tax into the amount being financed. Click here to access the calculator.
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