Rule of Thumb: How Much Car Can I Afford?

Every once in a while I get asked “do you think I can afford XXX?” and I think to myself this must be what it’s like to be Suze Orman. Since I’m throwing out rules of thumb, let’s get to cars. This will be a controversial one, but I like it and following it has worked out well for me.

Car Affordability Rule of Thumb

You can afford a car if you can pay CASH for it while still making timely progress on your other goals. I repeat: If you can’t pay cash for it, you can’t afford it. By cash I don’t mean retirement savings in an IRA, I’m talking about actual cash in the bank (or at least something you could quickly sell for cash in the bank).

If you have to justify it with “I’m in medical/law/computer/finance/basketweaving school and I’ll be making the bucks soon!”… no you still can’t afford it. If you justify it with “I need a brand new car because I need something reliable and anything less will explode! Do you want me to die???”… no you still can’t afford it.

Explanation

First, I’ve probably mentioned before that I appreciate cars. I still have Car and Driver magazines from 20 years ago. I wanted to become an ASE-certified mechanic for a while and even applied to automotive school, but settled on being a mechanical engineering major. But as someone who also values financial freedom, I also know that cars are the biggest area where the price paid vs. utility derived (i.e. value) can get completely out of whack. While a BMW M3 is a beautiful example of precision German engineering, unless your commute involves a German autobahn it won’t get you to work any faster than my 2001 Pontiac.

I’m also a proponent of individual choice according to personal priorities. I don’t think everyone who owns a Jaguar or Porsche is stupid. I think great cars are awesome, just like I think great buildings and great bridges are awesome. (Top Gear reference!) You may derive an obscene amount of personal joy out of owning and working on your car. But if you want to make a financially-smart decision, buy it with cash saved up after you put 15%+ of your pay aside for retirement.

What if I only have 50 bucks and need a car for work? Well, my first advice would be to try harder to find alternatives. Public transportation may be uncool, but so is being flat broke so I’d just get over it. Can you get a ride from someone, or carpool with a co-worker? Could you (gasp) bike or walk? If you absolutely have to finance a car, buy used and get a loan from a respectable place like PenFed which offers used car loans starting at 1.74% APR. Which brings me to…

Reliable car sweet spot? The “true cost” of a car is the sum of depreciation loss, maintenance costs, gas, and insurance. New cars hurt you on the depreciation front. Going too cheap may result in high maintenance costs overwhelming the low depreciation. Reasonable people can disagree on the exact number, but in my opinion you can minimize your “true cost” by buying a reasonably reliable car for about $4,000-$5,000. At this price, you can get a 10-year-old Civic or Corolla with around 100,000 miles and it will very likely run fine for many years if it was properly maintained. I personally like the idea of a more recent 2005+ GM or Ford with lower miles as Hondas and Toyota are currently fetching quite a premium. If you are especially knowledgable about cars and know what to look for, you could probably spend $2,000 and get a reliable ride.

I’m not saying everyone should drive a Corolla. But if you have to take on debt, I don’t think you need to spend more than $5,000. If you want something nicer, that’s what savings accounts are for. :)

Buying new. I’m fine with buying new if you have the cash. My parents are the buy-new-and-drive-til-dead type, and they’ve done well with that philosophy.

Financing or leasing. I said CAN pay cash for it, not that you necessarily have to pay cash for it. If you find a great 0% APR financing deal then go for it, but know that you can often exchange the 0% deal for a lower price. Leasing is usually forbidden in frugal circles, but in my view leasing is the same as buying new and agreeing to sell your car later at a predetermined price in the future. You can still negotiate a lease. If you have the cash, want a new car every 3 years, and hate dealing with repairs and selling cars, then there is a chance that leasing will work best for you.

Again, this rule of thumb won’t apply to everyone, but I think it’s a great rough guide to help those with growing salaries to manage lifestyle inflation. If you want a $40,000 luxury vehicle, you’ll have to plan ahead and save for it. When you’re staring at a nice $40,000 balance on your bank statement, it becomes much easier to weigh clearly the value of the car vs. your money.

As a final note, I hate “affordability calculators” based on monthly payments – that’s the same logic that encourages just making the minimum payment on credit card debt and spawned rent-to-own furniture! Save up and buy whatever car you want, but don’t fool yourself into believing you can afford a car just because the monthly lease payment seems manageable. In general, I think people spend way too much of their incomes on cars when they could have a paid-off mortgage instead.

Comments

  1. Jon,

    Just wanted to say how much I enjoy your blog. The content is never dull, and I have learned quite a bit.

    Cars can drive you into debt and misery. I drove my last car, an 89 Corolla for almost 20 years. In the last 5 years it looked awful but still drove well. So many people have cars for status. A car is only a way to get from Point A to B.

  2. Very good post and Hat tip for the Top Gear reference!! :D
    This is off topic but do you still watch TG? Their recent season was good as usual, especially the episodes about Jeremy’s P45 “car” and their Rugby game with Kia cee’ds.

  3. Alexandria says:

    Amen. I have the same rule of thumb on cars. My first car cost $1k (drove it for 7 years), then $5k, then $10k. I only got rid of the $5k car because it was a sports car convertible – had bought it like new and very low mileage. But it didn’t work with babies. I can’t decide if next vehicle will be $10k or $15k. I think $10k is kind of the sweet spot as we were able to buy practically brand new. But I admit I was able to do the same with my $5k car – it was just a much older model and the car I got did need a lot more maintenance than most any car I had owned. Was probably more model choice than anything.

    I was going to say, we are going to keep it in the $10k-$15k range as long as we have a mortgage. Two cars forward our mortgage should be paid off so I would not be surprised if we do $1k, $5k, $10k, $20k as the progression. Buying that $20k vehicle after being mortgage free will feel like quite a splurge. This means we could easily buy a very luxurious vehicle if it is a little used. (My parents bought a $50k luxury car for $20k – they have been driving it for 15+ years. !! I envision driving a deal like that).

  4. Alexandria says:

    Edit: I meant $1k, $5k, $10k, $15k, and finally $20k (when mortgage free).

  5. Hey, I’m sure the “gasp” after the biking or walking was a bit of a throwaway line – but biking is a pretty economical way to go for commutes of around 5 miles or less for most folks. Even if you already have a car it saves you on gas and maintenance. It generally doesn’t take that long, and saves you time you might have been spending at the gym exercising! No to mention no issues with traffic and/or parking.

  6. I bought my last truck new and drove it for more than 10 years. While I loved my truck, kept great care of it and sold it for a great price, I now have a 12 year old Civic I commute in and I must say, it was a revelation. I paid $3500 for it, and it had almost 200,000 miles on it. I test drove a couple others that had lower miles but this one clearly was taken care of, maintained well and was overall the best choice. I got the car just as place holder until I found a better one, but I’m keeping it now. I still take great care of it but I noticed that when I bought my truck new, it was mine from the beginning and I knew the history, which I thought I would like. As it turns out, personally, I like having a used car that I really don’t have an emotional attachment to. I don’t have to cringe at every rock chip or dent. Granted, I don’t completely disregard the Civic, but I don’t have the long personal attachment to it so as long as it starts and gets me to work at great MPG, I’m a happy camper. I doubt I’ll ever buy a new car again. I like to think I would drive them until they die but the truth is 10 years is the max before I get itching for a new car and buying used saves money and lets me get a “new” car every couple years for the same amount as a brand new car.

  7. My most recent car: a 10 year old Saturn for $4500. Had to put $1500 of work into it and it runs great. Hoping to drive it until it dies.

  8. I really like this blog because you mostly take a very nice analytic approach to personal finance. This post however falls short of the quality of your other posts.

    I think your point is that people should not spend a ton of money on a car. I agree, but the rule “only get a car if you have cash for it” doesn’t seem to be based on anything at all. I think it would be better to tell people that the sticker price isn’t what’s important it the True Cost of Ownership which includes gas, depreciation, repairs etc. Sometimes a new car is cheaper per mile than a used car. It all depends.

  9. I’ve always liked Suze Orman’s “if you can pay it off in 3 years” stance – but this is in fact better.

    Kudos for the Top Gear reference, too ;)

  10. Great post, but you fell into the new car depreciation hole that everyone does.

    New cars come with warranties, factory ones, the good kind. Most used cars don’t. So while a 3 year old car might look like it’s saving you money, add in the cost of a warranty and it’s not much cheaper than a new car.

    I just went through this exercise. New Ford Focus with factory rebates: $20k. Same car (same body style, trim level, options) but 3 years older on the same dealer lot: $17k. But that example was a rental car buy-back with 30,000 miles. The bumper-to-bumper warranty was over. So $3k buys you insurance against unforeseen repairs, and peace of mind knowing nobody drove your car…like a rental.

  11. Nicole C. says:

    Thanks Johnathan, this article is at the right timing. Recently I am tempted to buy a new car, especially the APR for financing is 0% for 36 months or 0.9% for 48 months. (money in online banks earn the similar interest rate anyway)
    Staring at $15k cash saving for car and 135K mileage car, I am trying to stick with “pay with cash” or “drive till it die” approach whenever appear first. :P

  12. i agree with most of your points. though, your discussion is more directed toward people who are single and young it seems. if you have kids it’s a different ball game. i have the same age car as you. factors coming into my decision making are safety, roominess, and getting an automatic so my wife can drive it. so 2/3 reasons are related to having children. you have a kid now, you should realize it’s not all about money sometimes, maybe it isnt about luxury, and just a family needs to have a bigger, more dependable, safe car and might need to go into debt for something other than an old death trap beater.

  13. My personal rule for buying a car: never take out a loan to buy a car. Actually, this applies to everything I buy except a house. It’s not because a house is too expensive, therefore I need a loan. It’s because a house (or more specifically, the land) will appreciate in the long term/overall. I don’t believe in borrowing to purchase something that will depreciate: cars, computers, appliances, etc. That’s pretty much everything except house and education.

    Americans treat car loans as the norm, but I believe it is financially irresponsible. If you can afford the monthly loan payments, then why not make monthly savings ahead of time, then buy a car with cash when you’ve saved enough? Until then, buy a reliable used car. Anyways, just sharing my view, I’m not saying everyone has to adhere to it.

  14. @Steve – Thanks for the kind words. 20 years is quite impressive.

    @Jake – Yes, I still watch Top Gear UK. The most recent Africa special was pretty good, the last India special was not. Top Gear USA was a bit painful in the beginning, but their new season is better.

    @Alexandria – Sounds like a good plan to me!

    @Tom – I think biking is a fine option, obviously much easier in certain circumstances (weather, bike lanes, distance) than others. I essentially biked a couple miles to work in grad school for 3 years.

    @Brett – See, I think people tend to underestimate the quality of cars today. Yes, some parts will wear out but the true cost total is still quite reasonable.

    @Spencer – I hope that’s a long time.

    @Kerry – The key here is that I’m not telling you what car you *should* buy in order to maximize value (indirectly covered though with sweet spot point), but instead a rule about *affordability*. If people just bought cars they could “afford” according to my rule, there would still be a variety of cars out there (fast, expensive, cheap, big, small).

    @Charlie – Poweeeerrrr!! ;)

    @Colin – New cars can be fine, just pay cash. Fords and GMs are cheap new, and even cheaper on the used market with depreciation if you look hard enough. The repair bill on a new car for the first 3 years should be between $0 and $1,000 with or without warranty. But again, buying new is fine.

  15. @Nicole – I’m sure you can find a great car for $15k. Lots of good options in that range, you can even get a new Honda Fit for close to that.

    @gt – I hardly think that a 2005 Ford Taurus is a death trap. It’s a mid-size sedan, has LATCH carseat anchors, airbags (not good for kiddos but good for us), even stability control was an available option. I understand the desire for a big car for the kids, but to me that just means spending a few grand more if we’re talking value maximization. But again, the point of this post is you can buy whatever you want if you have the cash.

    @Bucky – I think avoiding a loan is pretty much the same thing as paying cash, no? :) I’ve never had a car loan and likely never will. When I buy a car, I bring my checkbook.

  16. Another way to save cost if you cannot afford any car is to use Vanpool (http://www.enterpriserideshare.com/vanpool/en.html) – many employers provide this for free as a benefit, but even otherwise, it is fairly inexpensive to vanpool.

  17. @Mihir – Yes! I forgot, here is an excellent guest post on vanpooling:

    http://www.mymoneyblog.com/van.....tives.html

  18. I drive a 1990 Geo Prizm. 23 year old car that I have been driving for the last 20 years (bought used!). Every year I bump into someone I haven’t seen in some time and it’s the same old line – “You still driving that shit box?” Yes. Yes I am. Mileage isn’t bad, air blows frosty and maintenance has been extremely cheap. Other related costs like insurance and registration are very, very low. I’m driving it till one of us dies and the way this car just keeps on motoring I’m not sure who it’s going to be.

  19. Also don’t forget about ride sharing options like Zipcar

    I have the cash to get just about need car, however I just can’t justify spending 5k+ for something I don’t really need.

    With my smartphone I can navigate public transit system with ease. For example I know within a minute if the bus is coming late and come to the stop late. While on the bus I usually watch movies and Google maps alerts me when to get off. In comparison when I drive I find it too stressful, especially when stuck in traffic.

  20. Jonathan – I can’t say I NEVER had a car loan, but pretty close. I got a 36-month low interest loan from GMAC when I bought my first car, a brand new (as in, I put every mile ever on that car) 1986 Chevrolet Camaro. Paid that one off and put the payment in the bank for the next time.

    And the topper – I just put antique plates on that Camaro, to save on insurance and registration. 27+ years on a Camaro, not bad, huh?

  21. Jonathan – another great post! I am big BMW enthusiast and always thought a car was a necessity. I am hoping to be car free once my lease is up as I am finding public transportation, car sharing and taxis more convenient than owning a car I take out once a week! For anyone interested in buying a car, I found that the following in a spread sheet helps to understand what a car really costs.

    Monthly Payment
    Home Parking (typically if you rent an apartment)
    Office Parking
    Insurance
    Tax/Title/Fees/Registration
    Tickets
    Repairs
    Misc Parking + Fees
    Gas

    Even if you pay cash and eliminate the monthly payment, look forward to having all of the rest as fluctuating payments every month.

  22. Another huge postitve for buying used is being able to negotiate the price down much more then on a new vehicle. A poster above mentioned a used car on a lot being only 3k less the the same one new. You don’t have to pay anywhere near what the sticker is on a used car lot if your willing to work a little.
    I have a few BKM’s Ive developed over the years. I don’t know if they apply to all dealerships but they have worked for me.
    1. Look for a used car at a different brand dealership (eg I bought a Buick at a Toyota dealership). My theory is there is less demand for a Buick then a Corolla if you are shopping at a Toyota dealership and they might be willing to slash the price to get rid of it vs one of their own brand cars. They probably got this car via trade in or at an auction, so they have wiggle room.
    2. Shop the last day of the month. Big dealers tend to have sales goals tied to each month and they will be more willing to move cars at the end of a month to meet quotas.
    3. Shop on a day nobody else will be. If its pouring rain you may be the only person at the dealer. Black Friday is huge for retail but I found almost nobody at a car dealer last time I tried this.
    4. Be willing to walk away when negotiating. If you don’t get what you want, leave, they might chase you down as you are driving away (happened to me).

    My best example of the above strategy worked for me buying my current car, a 2001 Buick Lesabre. I bought it from a Toyota dealer on the last day of a month in 2004. It only had 30k miles on it and sold brand new for 27k 3 years earlier. The dealer had it listed for 13k, I got it for 6.2k. THey told me no chance as I was negotiating about 15 times. I didn’t budge, and eventually left, or tried to. As I was pulling onto the street I saw 2 salesmen chasing me. I got my deal and still drive this car today. A 3 year car still under warranty for a few months for a tick over 6 grand. Hard for me to imagine ever buying a new car.

  23. @ Ron:

    Your point number 4 about being willing to walk away reminded me of this Marketplace Money segment in which an FBI hostage negotiator talks about how he negotiated on his last vehicle purchase:

    http://castroller.com/podcasts.....ed/3220566

    A good listen.

    - another Ron

  24. subscribe to this blog because of quality content in my opinion as I would presume everyone who follows this blog are frugal in their own ways.

    read this content in my email today and do agree with it and with some other opinions the readers posted. sometimes I also feel this way, “Sometimes a new car is cheaper per mile than a used car. It all depends.” which led me to this post.

    If I buy into a vehicle that is new, I have to make sure that I get the ultimate return of my investment by driving it until I can squeeze the usable life out of a car. My wife and I haven’t own a new car as of yet. I just bought in my opinion a quality buy of a minivan for $3K last fall to accomodate my growing family of 5 to replace what I consider my 18 yr old Camry having 302K miles on it with cost of repairs that isn’t worth it no longer (still has it though, use it sparingly nowadays). on the other hand, my wife is driving a 13 yr old maxima having 190k miles with a engine code error that needs to have a part replace for emmission purposes only and is eating up further on gas consumption because of that clogged part, otherwise good condition. cost to fix is $500-$1200 depending on replacement part. fuel econ of maxima is 18/26 city/hway new. monthly gasoline cost for maxima is at least $250/month and requires a premium gasoline to point out. wife drives 80 miles RT for work.

    so given that, thinking of getting a new better fuel econ car to replace the maxima. first thought would be the cheapest car in the market in versa simply because of financials but still on the fence again because of financials. just recently I’ve been researching the totally EV nissan leaf where nissan dropped the price and offered a enticing lease to boost sales but then again the author said, “don’t fool yourself into believing you can afford a car just because the monthly lease payment seems manageable.” with all the incentives to buy into an EV vehicle, car can be had for $18K accdg to the site and lease on the other hand is $199/mo with $1800 down. (Net capitalized cost of $19,631 includes a $595 non-refundable acquisition fee. Dealer contribution may affect actual price set by dealer. Monthly payments total $7,164 At lease end, purchase for $14,529, plus purchase option fee up to $300 (except KS & WI), plus tax, or pay excess wear & use plus $0.15 per mile for mileage over 12,000 miles per year. Lessee is responsible for maintenance and repairs. A disposition fee is due at termination of lease term.)

    there’s more to the fine print I’m sure but this is where I feel new is sometimes better than old but still IN THE FENCE again due to financials. I would like a point of view from the author of the blog and the readers alike about this. on one hand, don’t want to spend gas that much and if I had to, rather pay that on a EV monthly lease that goes towards the value of the car before I can ultimately purchase it for the residual OR buy the versa and still pay gas but cheaper. ???

  25. P.S. – My current daily driver is a ’96 Toyota Avalon that my wife bought used in ’99 (cash). Comfortable, still looks good (well, the body has held up – it does still look like a ’96 Avalon, after all), decent milage and 300+k miles on it with only needing routine maintenance (tires, belts, brakes, tune-up stuff).

    It just keeps going.

    - still the other Ron

  26. Great topic!

    I search for original owner and excellent maintenance. You may pay more for a used Honda or Toyota but they’ll go 200K if you treat them right.

    Every car eventually goes to zero (no value). It’s hard to think of them this way.

  27. washerdreyer says:

    Funny timing on this post, I just today bought a ’12 certified used Focus. In this crowd, I’m a little afraid to admit it, but I did get that PenFed loan at the rate quoted in this post. I have the cash on hand to buy it, but currently home shopping and need to keep the money for down payment purposes. Total interest over five years is $503.55, that seems pretty reasonable to me, and let me get an almost new car at a price I was happy with.

  28. @washerdreyer – Sounds like you did just fine, enjoy your new Focus! If you’d like to write a guest post about your car loan experience at PenFed, please let me know. I’m curious as to how the details works for a used car. Thanks!

  29. Dona Collins says:

    I can’t tell you how many times I’ve seen people make or plan a purchase with the money they have in the bank because, “I’ll get paid on Monday…” or “I am going to get a new job…” or – fill in the blank with an excuse. Something always goes wrong and then they can’t afford food, rent, gas. Priorities are important. Don’t buy it if you don’t have the money for it. Period!

  30. I tend to disagree that this works for all. About 17 years ago while I was getting my MBA, I needed a new car. Thought about buying a used one since I was still in school, but opted for a brand new Mercedes. The thinking was that I was going to be getting a full time job in 1 year as a newly minted MBA and would be able to afford it. I would plan to keep the car for a long time and a quality car would last that long. I want something I would enjoy driving for years to come rather than compromise and take the cheaper route. I did not want to get another car in 5-6 years.

    So now 17 years later, I still drive my Mercedes and love it. I have 165,000 miles on it and over the 17 years, the car has cost me less than 2-3 used cars would have cost me (I use 2-3 since I guess I would have to change cars every 5-6 years). Sometimes new is better.

  31. A friend had a leased EX35 and used penfed to buy the car out at the lease end as Infiniti wildly under-estimated its residual value. My friend said the Infiniti dealer’s jaw dropped when he revealed the rate. most people do not know penfed. Weird.

    As for cars, I’m a car nut and it’s my one huge vice. I’ve had 8 cars in 13 years. Some were leases, some were purchases, some were used and in the end I only regret parting ways with my 2003 330i ZHP.

    In some cases the cars didn’t really cost me much over a year (like my lemoned 335i cost me less than $500 to use for a year or my commuter car Protege that I resold after 2 years for a loss of $1000 total). Other times I blew 5-6k over a year. In all instances though I’d rather keep my cash on hand for investment properties, stocks, etc.

    Cars depreciate like crazy most of the time. Buying a new car for cash for me is a bigger waste as I haven’t kept a car more than 3 years since the 90s. If I followed logic, I’d go buy a 3-4 year old honda accord and drive it for 7-8 years. But I love driving too much to do that.

    And I know it’s wasteful to burn through cars. Shrug. Some people spend thousands on vacations or computers/hifi or $200 a month cell phones or several hundred a month going to bars/starbucks. I waste a few percent of our income on cars. Hell, the profit from my rentals more than pays for the cars.

  32. Thank you for this post and for your blog.

    I am 53 and lets just say that I have approached your level of financial intelligence gradually over the past 30 years, after learning the hard way (credit card interest, bank fees, loan interest, investment mangement fees, inflated self-regard for stock picking, etc). I luse your well-articulated posts to teach my children, as well as my retired parents.

    Cars are always a depreciating asset, and unfortunately make up a huge percentage of most people’s financial “portfolio”. We have a couple of used cars that annoy us from time to time, and enough cash to buy new cars. The old cars aren’t worth much, so keeping them involves little depreciation cost, and maintenance remains modest. We go through the urge to buy something twice a year or so. When faced with the choice of giving up hard-earned savings, we always back down. It helps to be nice to the old car. Clean it, replace the wiper blades and floor mats, fix the broken trim. Then keep it for another year.

  33. Omar Little says:

    The crazy thing is that I’ve read some articles saying “spend no more than 10% of your monthly income on a car payment”. That seems very high if you are making decent money!

    What do you think of Dave Ramsey’s guideline- your cars’ total value should not be more than 50% of your HHI?

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