Wish to buy the car of your dreams but have little resources for an outright purchase? A car loan would serve as a smart alternative to cash payment. By availing an auto loan that you can afford, you can zip around in the car of your choice in no time. But wait, car financing decision cannot be taken in a hurry. You need to assess how much new or used car loan is affordable for you beforehand and there are a few major factors that can help you determine that.
Calculation of Monthly Income
Before you purchase a vehicle, be it of any make or cost, it is essential to take a close look at your budget. A general recommendation is that your automotive budget must not exceed 20% of your overall take-home pay. Also, this slice of your budget should include not only the auto loan EMI but also all the other car-related expenses, such as oil, car maintenance, gas, car insurance, etc.
In case you already have high monthly costs or other debts to feed, then you may like to scale off your car loan budget a bit. It’s best to stick to the bottom of your available budget as you can never be too sure of what may come up next.
Factoring in of Credit
The interest rate on your auto loan is one of the prime factors in determining its extent and amount. Pull out your credit score or credit report to estimate whether your credit is good, average or bad. The rate of interest applicable to you would be higher if your credit rating is weak, and vice versa.
Then, factor in the car down payment, which, on an average, should be about 10.5% of your car's price. Once you are armed with these figures, you have enough ammunition at hand to calculate the range of auto loan that you can afford.
The Mileage is Important Too!
Is your company offering you a mileage reimbursement? If yes, then your car purchase becomes more affordable if you succeed in selecting a car with a good fuel mileage. If you are not expecting any employer-side reimbursement, then the gas expenses would eat into your monthly budget. So, it is a good idea to save more by committing yourself to a lower and more affordable car loan.
The Thumb Rule of Auto Loan
The 20/4/10 ratio of auto financing will show how much you should be spending on your car buy.
1. Your new car will lose about 9% of its value once it is driven off the lot. It would have lost 19% by the end of the 1st year of purchase. By putting down less than 20 percent, the risk of your debt value being more than what your car is worth increases manifold.
2. With a longer term loan comes more interest and higher lender insurance requirements. While three years would be the ideal term for paying back your loan, four years will be the maximum that you can expect to gain the value for your car.
3. The total cost of principal, interest and insurance should not eat into your budget. By staying below 10 percent, you can still take care of your other expenses, a home down payment, emergency funds or a nice vacation. Also, a job loss or a pay cut would not feel like an albatross around your neck.
Rules aside, all situations are different, so opt for your car loan accordingly.
The Last Word
The above factors are best considered before you start inquiring about the diverse finance options or initiate your car shopping processes. With the right inputs in place, you will be able to assess how much car loan you can afford.