It was more than ten years ago, but I still remember driving to the car dealership in my 1993 Chevy Lumina with the maroon interior. It served me well through college and I even used it to drive my future wife on our first date to the Oklahoma State Fair… astonishingly, neither the car or the first date at the fair scared her away!
After arriving at the dealership, I walked up with confidence, ready to prove I was an adult. With my degree in Finance and a good job making $45,000 a year, I thought I deserved a new car. I didn’t think about how much car I could afford, but only about that new car smell.
They only gave me $500 trade-in on my Chevy Lumina, but it didn’t matter, I was ready to buy. They didn’t care either as they can see a sucker from a mile away! They happily complied with my “confidence” and financed my new $28,000 Xterra with no down payment and only a $500 trade-in, but with a “great” 2.5% loan.
Two years later, it all came apart. I was tired of working my butt off and not making any progress on paying 0ff my over $50,000 in debt. That’s why I now use the 20% rule to determine how much car you can afford based on your salary.
How much car can you afford based on salary?
The math is simple. How much money do you make in a year? Take 20% of your gross annual income (before taxes, social security, etc) and that’s how much car you can afford. Preferably, you should purchase with cash as well.
If you are in a relationship and you combine salaries, you should add up both incomes and divide by two. If you want, you can split the amount up differently (60/40, 70/30, etc), but make sure you don’t surpass the 20%.
Quick example: one person makes $40,000 and the other makes $30,000. The combined salary of $70k means $14k worth of cars can be purchased. If you need to buy two cars in one year, you can split up the $14k however you’d like – keeping in mind the majority will probably go to the wife.
Cheat sheet on how much car you can afford:
- $20,000 salary = $4,000 car
- $40,000 salary = $8,000 car
- $80,000 salary = $16,000 car
- $140,000 salary = $28,000 car
- $200,000 salary = $40,000 car
That means when I purchased my $28,000 car, I should have spent $9,000 instead (based on my $45,000 salary X 20%)! I was $19,000 over which explains why I was broke.
Adopt a millionaire mindset
Even though I was a finance major, I never learned how to get rich. It took me three years of bad decisions and perpetual brokeness to finally realize I didn’t know what I was doing. Now, thanks to people like Dave Ramsey and books like The Millionaire Next Door, my wife and I are in the mindset.
According to Dr. Thomas Stanley, “86% of those who drive prestige makes of motor vehicles are not millionaires [having an investment portfolio of $1M or more – see Stop Acting Rich].” Contrary to the crap we see on TV like the Kardashians cruising around in new G wagons, the majority of expensive-looking cars aren’t driven by millionaires, they’re driven by people only trying to look rich!
How much do millionaires actually spend on their cars? Dr. Stanley’s research shows “the median price paid for the most recent motor vehicle purchased by a millionaire was $31,367 [for decamillionaires-$41,997].” That’s right, millionaires only spend on average of $31k on a new car, or 3.1% of their incomes!! We bought a used car last year at 7-8% of our annual income and it’s been great.
The next secret to buy a car you can afford is to pay for it with cash. That’s right. Cold, hard, cash. We’ve been duped into spending our hard earned money on expensive cars for way too long and it’s even easier now that we can get 72 or even 84 month loans.
I don’t know if would’ve done it differently ten years ago when I walked into that dealership if I had the choice. It taught me to hate car loans and only purchase cars I could afford. It propelled me to really start learning about personal finance and trying to help others make smart financial decisions. It helped us travel the world in 2013 and is helping us pursue early retirement now.
If you need to learn how to take control of your finances, I’ve detailed out the steps I used here.
Do you agree with the 20% rule to determine how much car you can afford based on salary? We’re having a great debate in the comments section, so please add your own!
P.S. Do you want my opinion on if you can afford a new car? Add your comment below, and I’ll let you know what I think. You can also ask through tweet @YLTL