It was brought to my attention that lately a lot of my posts have been more philosophical in nature and that people would like to see a few more practical posts with general rules of thumb and other more concrete takeaways. So, to my caring friends who made the recommendation, this post is for you.
The question I wanted to tackle this week is, how much can you afford to spend on a car?
As with all financial questions, there’s no one answer that works for everyone, but the general rule of thumb for determining how much you should spend on a car is pretty simple. Most financial institutions and experts agree that your car-related expenses should be 10% to 15% of your gross income. I’ve also heard people say up to 20% of your take-home pay (after taxes), but I like the 10% rule because it’s simpler.
For example, let’s say you make $5,000 each month. Using the 10% rule, the total amount you should spend on your car — including your loan payment, gas, insurance, and maintenance — is $500 per month.
If you wanted to take this rule of thumb as law, here’s what annual salary you’d need to afford these cars:
Tesla Model Y ($63,990) – Minimum salary needed would be around $135,000 a year.
Rivian R1T ($83,000) – Around $170,000 a year.
Ford F-150 ($59,095) – Around $141,000 a year.
Toyota RAV4 ($38,350) – Around $95,000 a year.
Honda Accord ($25,470) – Around $71,000 a year
Lamborghini Aventador ($789,809) – Around $1,680,000 a year. Although most people will lease their exotic cars which is cheaper than buying.
*I’m making a lot of assumptions in these calculations with insurance and gas costs, registration fees, etc. The calculations are based on current interest rates, a 5-year term for the loan payments, and a 5% down payment. I also realize that 7-10 year loans, which will lower your monthly costs, are not uncommon nowadays. Whether or not they’re advisable is for another post.
Go Banking Rates released a study that looked at the salary level required in each state to purchase a new car. They estimate you need to make nearly $82,000 per year on average to be able to afford a new car.
Obviously, there are plenty of people not adhering to the 10-15% of gross income rule for their car purchases because $82,000 is more than double the U.S. median household income and yet millions of brand new cars are still sold every year. As I mentioned at the beginning of the article, not everyone needs to strictly follow these general rules, but this does lead me to a point I want to make.
The cost of transportation is typically the second biggest fixed cost in people’s budgets behind housing, and expensive cars can blow up your finances if you’re not careful.
Last year the Wall Street Journal shared a story of a couple who was struggling as their income was upended because of the pandemic and they had a lot of consumer debt:
“The Denton, Texas, couple pay $4,400 a month on their mortgage, four car loans and leases, and student debt, Ms. Scott-White said. Minimum required monthly credit-card payments total about $700. The debt was manageable pre-pandemic, she said.
She deferred lease payments on her Infiniti QX60 for three months and started paying again with unemployment benefits. Her husband traded in his Ford F-150 in August for a lower-cost car and reduced his original monthly payment of $820 by about $100, and his income covers the $2,100 mortgage.”
There are a lot of things going on in this excerpt, but the Ford F-150 payment stuck out to me here. Maybe it’s just because I live in Utah and I see a lot of trucks on the road, but a monthly payment of $820 is quite a bit of money.
The Ford F-Series trucks have been the best-selling vehicle in the U.S. for 40 straight years. In fact, the top 3 best-selling vehicles in the past 7 years have all been pick-up trucks and more than 13.2 million new pick-ups have been sold from Ford, Dodge, and Chevy in that same 7-year span.
New trucks run anywhere from $50,000 to 90,000. For a 5-year loan at 3%, that’s a monthly payment in the $800 to $1,400 range depending on your down payment. And that doesn’t include gas, insurance, and maintenance.
No wonder people have a hard time saving for retirement. It’s not good to judge other people’s spending habits, but sometimes I can’t help but think to myself when I see a decked-out truck or SUV on the road, “Do they max out their 401(k)?” or “Do they have an emergency fund set up because you can’t spend that Land Rover in a pinch?”
The difference between the monthly payment on a $50,000 car and a $25,000 car is almost enough to max out an IRA each year. The difference between a new $75,000 truck and a $25,000 used model would be enough to fund 60% of an annual max 401(k) contribution. Not to mention that vehicles depreciate every year while retirement savings grow over the long term.
To be transparent, I’m not a car person. Some people love cars way more than I do and I don’t want to tell people what they should or shouldn’t spend their money on.
Personal finance is all about managing trade-offs. You might not spend a lot on clothes or vacations and you decide to put more money toward a nicer ride. Or maybe you make enough money where car payments aren’t a big dent in your budget.
But if you’re struggling financially and not able to save as much as you’d like for your future, there’s a fairly simple remedy. Driving an inexpensive car is one of the biggest levers you can pull to free yourself up financially.
Thanks for reading!