If you stop any random person and ask them what their greatest fixed monthly expenses are, chances are that (besides their mortgage) they’ll all give one answer: car payments.
It makes sense; America is a car culture, and cars are by no means cheap items for a household to afford. Most of us average Americans can’t afford to buy a car with cash, so that leaves us paying off our cars until it’s time to get a new one and we restart the whole cycle.
Because they’re such a prevalent part of our everyday financial situation, today we’re going to zero in and try to answer a very simple question. What size car payment is right for you?
It’s a harder to question to answer than you’d think as it encompasses market realities, income, interest rates, and credit scores.
Before we get started on figuring out what’s right for your situation, it’s a good idea to understand the broader context of car payment and loans in the country as a whole. A recent study offers some insight on auto loan trends that are worth discussing:
“In 2016, Americans applied for and racked up $564.6 billion in auto loans. By the end of 2017, that number had jumped to $568.6 billion. The auto loan industry has seen consistent gains with no signs of slowing over the past six years. Still, many of us appear to be missing payments: 4.1% of active accounts were delinquent 90 days or more at the end of 2017.”
This quote helps sets the stakes for car loans as a whole and why it’s important to find one that fits you and your financial situation. Missing car payments is catastrophic for your credit score, and a ruined credit score can cascade into all kinds of future financial problems.
How do you make sure that doesn’t happen to you?
The amount of money you make isn’t going to suddenly change once you get a car. This is just a fact, yet many people somehow don’t seem to grasp it.
Your car payment needs to be able to slot into your current budget or you simply won’t be able to keep up with it. And to know if a given payment can slot comfortably into your budget you first need to know what your budget is.
We’ve written before about setting up an effective and accurate budget, but the quick version is that you just need to track how much money is coming in and subtract it by how much on average is leaving each month. Whatever’s left over can go towards potential car payments.
Besides the number you’ll be shelling out in monthly payments, the next biggest consideration is what the length and interest rate of the car loan will be. While it may not be obvious on the surface why these two variables are grouped together the reason is actually pretty simple, and it’s because one directly affects the other.
While the length of your loan and the interest rate are generally negotiated separately, it’s important to know that the total amount of interest you pay goes up the longer the loan is for. If, for example, your interest rate is at 4% that’s 4% applied to the money you owe each month, not the loan in total. The longer you take to pay off the loan the more months that pass, and the more times 4% is charged.
The above is one of the reasons that while it may be tempting to pay less each month, it sometimes makes sense to pay your loan off faster as it means that you’ll pay less total over the lifetime of the loan.
One of the most overlooked aspects of getting and paying off a car loan is the actual car itself. It’s strange that what car you pick is the single biggest determiner of how high your car payments will be, but the two concepts are still treated by too many people as distinct decisions. Either you pick the car and then try to figure out how to pay for it, or you decide on what you want to pay and pick the car that fits the payment.
Both of these are flawed ways of buying a car, and you should instead think of them as a single holistic decision. You’re going to have to live day to day with both your car and it’s payment, so make sure both suit your lifestyle.
For example, if you have four kids, you’re going to need a van regardless of whether it has the ideal interest rate attached to it, while on the other hand the payment on a lamborghini will quickly reduce you to a pauper unable to afford the gas to drive it. Think carefully about the interplay between car and payment before committing to either.
Along with a standard car loan, another short-term lending option is to take out an auto title loan on an existing car you own to pay for the new one.
While this often isn’t viable if you’re a single person, for a household that needs a second or third car it can actually make sense. Just be sure that the car you’re taking the auto title loan out is itself already paid off in full, as that’s one of the criteria to be accepted for an auto title loan.
Ultimately no one knows your financial situation except for you, but the above factors should give you a good idea of where you stand and what’s right for you. A car loan doesn’t have to be a headache, and if you follow our advice it won’t be.