Buying a car is a big financial commitment. Here’s how to calculate how much you can afford

But for many Americans, the purchase of a new car is sometimes a non-negotiable if they rely on a vehicle to get to work, get their kids to and from school, or don’t have a reliable public transportation system to lean on. 

Determining how much you can comfortably afford will ultimately depend on your personal budget. And even then, with car buying costs having increased significantly, many buyers are finding themselves stretching their budgets to the limit in response to interest rates and rising sticker prices. 

The cost of becoming a car owner has increased 

Edmunds data from November 2022 showed that the average transaction price for a new vehicle hit a record high of $47,681 in November 2022—but this was also the first time since July 2021 that the average transaction price came in below the average MSRP (sticker price). In November 2022, the average MSRP dropped to $47,696. Experts noted that this drop in price predominantly impacted larger trucks, SUVs and luxury vehicles, but lower-priced vehicles still saw an increase in price and demand. 

“Car-buying costs are definitely on the rise,” says Andrew Stuart, EVP, TD Bank AMCB, Head of TD Auto Finance US. “Some of the contributing factors include rising interest rates and the cost of vehicles themselves. Safety and technology advances in automobiles, combined with investments in hybrid and battery electric drivetrains have steadily increased the average cost of a new vehicle. Part of this is being driven by historically low new vehicle supply as a result of the pandemic’s impact on supply chains. If dealers do not have a strong supply of inventory, they are less willing to negotiate on price.” 

With higher interest rates becoming the new norm, many car buyers are settling for higher monthly payments. The same Edmunds report showed that 15.7% of consumers who financed a new vehicle in Q4 2022 committed to a monthly payment of $1,000 or more—the highest it's ever been—compared to 10.5% in Q4 2021 and 6.7% in Q4 2020.

Figuring out how much car you can afford 

Buying a car is a massive financial undertaking and should be carefully thought out. Experts suggest weighing the following factors when making your financial game plan for your purchase: 

Consider your monthly budget 

The amount you can afford to pay for a vehicle will depend on your budget. As a general rule of thumb, many experts suggest following the 20/4/10 rule, which holds that you should set aside 20% of a car’s purchase price for a downpayment, take 4 years to repay your car loan, and ensure that your monthly transportation costs don’t exceed 10% of your monthly income. 

These are just guidelines, but it can be helpful to use these parameters to figure out how much you can comfortably afford to pay upfront, and how much you can afford to spend on recurring car-related expenses. 

“Determine your after tax income,” says Stuart. “Transportation expenses should be considered along with housing, food, entertainment savings etc. Once you determine the amount your individual circumstances will allow you to spend on transportation, think about the other expenses beyond your car payment that should be a part of your budget. This will include things like insurance, fuel and maintenance expenses.”  

Think about all of the costs you’ll be responsible for apart from your monthly payment 

Other considerations may include an extended warranty to cover costly repairs that could crop up, or gap insurance, which, in the event of an accident, covers the difference between what your vehicle is currently worth and the amount you actually owe on it.

Insurance, fuel, and maintenance costs can be drastically different depending on the vehicle you’re interested in purchasing. And if you plan to finance that vehicle, which most buyers do, your credit score will play a major role and the interest rate you can secure on an auto loan. 

Taking the time to compare financing options before you decide on a vehicle can help you determine which of your options is the best route to take long-term, how that payment will factor into your monthly budget, and how long it will take you to repay that loan at the current rate. 

“Other options to think about is to secure financing outside of the dealership,” says Joseph Yoon, Edmunds' consumer insights analyst. “Say you’ve been going to the same bank for a while, or there's a local credit union that's running some special interest rates for new car purchases, I think that's a good way to kind of flip the table in your favor just a little bit, even if it's by a couple points because it adds up.” 

Use a loan calculator tool to crunch the numbers 

There are several online calculators that can help you determine if your car payment will fit neatly into your monthly budget. Typically, you’ll need to provide your credit score range, price of the car you’re considering, loan terms, the interest rate you’ve been quoted, and the value of your trade-in vehicle if you have one. 

“There's plenty of loan calculators out there that you can use to figure out the ballpark of what your monthly payment is going to be when you're trying to figure out ‘does this car fit into my budget or not?’” says Yoon. “And most manufacturer websites do advertise their current interest rate so that'll be something of a reference point.” 

3 tips for cutting your car-buying costs 

While there’s no way to control the sticker price of the car you’re interested in purchasing, there are moves you can better position yourself to secure the best deal on your vehicle. 

1. Boost your credit score. When it comes to your auto loan rate, your credit score plays a major role in how likely lenders are to offer you a lower rate or not. “Higher credit scores will generally receive a more favorable rate. I would always recommend that a first time buyer know their credit score before they start to negotiate rates on a car loan,” says Stuart. There are a number of convenient ways to check your credit score, and if you find that your score is lower than you anticipated, you can request a free copy of your credit report from each of the three major credit reporting agencies each year. Reviewing your report can give you a more in-depth look at the factors that could be hurting your score so that you can make a plan to improve it before you head to the dealership. 
2. Make a larger down payment. If you can afford to make a larger down payment on your vehicle, experts agree that it pays to do so. “Coming in with a 10% down payment and a strong credit score will put a first time buyer in a very good position to obtain a market competitive rate,” says Stuart. “With that said, it's not just the rate that should be considered. Think about how much payment you can afford as you are making your car buying decision. It may make sense to accept a slightly higher rate over a longer term to get a payment that fits your individual budget.” 
3. Use your current vehicle as leverage. Don’t let the new car smell distract you from the value your current vehicle holds. You could significantly reduce your upfront and long-term costs by trading in your vehicle. “If you're trading in the car that you used to drive, try to leverage that as much as possible. And hopefully that one is paid off so you're not rolling bad equity into a new loan,” says Yoon. “That will be your biggest bargaining chip to get a good deal.”