How Much Car You Can Afford (By Salary) | Lighthouse Financial

How Much Car You Can Afford (By Salary) Episode 140

A car is often one of the most significant financial investments you'll make in your lifetime, apart from your home. Yet, many people find themselves financially trapped due to poor car-buying decisions.


In this article, we’ll guide you through the process of making informed decisions about car ownership and help you avoid common financial pitfalls. A car is often one of the most significant financial investments you’ll make in your lifetime, apart from your home. Yet, many people find themselves financially trapped due to poor car-buying decisions. We’ll show you how to avoid this trap and make choices that align with your financial goals.

Determining How Much Car You Can Afford

First things first, how much car can you actually afford? One rule of thumb, popularised by financial guru Dave Ramsey, suggests that all your vehicles’ combined value should be less than half of your annual take-home salary or up to 5% of your total net worth.

For example, if your annual take-home pay is $100,000, your vehicles’ total worth should ideally be less than $35,000. Similarly, if your net worth is $1,000,000, your cars’ combined value should not exceed $50,000. These guidelines help ensure that your vehicle expenses don’t overwhelm your overall financial picture.

The 20/4/10 Rule: A Practical Approach

To make smart car-buying decisions, consider the 20/4/10 rule:

  1. 20% Down Payment: Start by putting down a minimum of 20% of the car’s purchase price as a down payment. This not only reduces the amount you need to finance but also improves the loan terms you’ll receive.
  2. Four-Year Loan: Aim to pay off your car within four years or 48 months. This strategy minimizes interest payments and ensures you own your vehicle sooner.
  3. 10% of Pre-tax Income: Keep your total transportation costs, including the car payment, under 10% of your pre-tax income. This includes financing, fuel, insurance, maintenance, and any other related expenses.

Following these guidelines can help you budget responsibly for your car and prevent it from becoming a financial burden.

New vs. Used: Finding the Sweet Spot

While some people prefer the allure of a brand-new car, financial wisdom often advises against it. New cars tend to depreciate rapidly, losing 40% to 50% of their value within the first five years. Instead, consider looking for cars that are between three to six years old. They offer a good balance between modern features and minimised depreciation.

Remember, it’s essential to buy or sell before your car hits major mileage milestones, like 100,000 kilometers, as they can affect the car’s value and maintenance costs.

Hidden Costs of Car Ownership

When calculating the cost of car ownership, it’s crucial to account for all expenses, not just the upfront purchase price. Consider factors like:

  • Financing: If you choose to finance your car, interest rates can range from 6.5% to 15%, impacting your overall expenses.
  • Gas Mileage: The cost of fuel can vary significantly depending on your car’s fuel efficiency and how much you drive.
  • Insurance: Insurance costs are influenced by factors such as your age, driving history, location, and mileage.
  • Registration and WOF: You’ll need to budget for annual car registration and warrant of fitness (WOF) inspections to keep your vehicle legally on the road.
  • Maintenance and Repairs: Maintenance costs can fluctuate widely, especially for luxury cars. Major services, like brake repairs or cambelt replacements, can be substantial expenses.

Buying Methods: Cash vs. Finance

In an ideal world, you could pay for your car in cash. This means no loans, no monthly payments, just outright ownership. However, for many people, this isn’t realistic. If you decide to finance your car, remember the 20/4/10 rule we discussed earlier.

For example, if you’re considering a $65,000 car, putting down 20% as a down payment, financing it over four years at an average interest rate of 12.89%, your monthly payments would be around $1,399. Over the four-year term, you’d pay approximately $15,152 in interest.

Conclusion: Making Smart Car Choices

In conclusion, making smart car-buying choices involves understanding the total cost of ownership, following budgeting guidelines like the 20/4/10 rule, and considering your long-term financial goals. While a car can provide enjoyment and convenience, it’s essential to ensure that your purchase aligns with your financial plan and doesn’t hinder your path to financial freedom.

For a no obligation discussion to see how we can help you on the path to wealth, please contact us.

The information in this article is general information only, is provided free of charge and does not constitute professional advice. We try to keep the information up to date. However, to the fullest extent permitted by law, we disclaim all warranties, express or implied, in relation to this article – including (without limitation) warranties as to accuracy, completeness and fitness for any particular purpose. Please seek independent advice before acting on any information in this article.