Determining your budget for purchasing a car.

What is the appropriate amount to spend on a car, which is often one of life's largest expenses?

The car-buying process is a complex journey that depends on your specific needs, financial situation, and loan terms, according to Patrick Roosenberg, senior director of automotive finance intelligence at J.D. Power.

CNBC Select provides a breakdown of the budget for purchasing a car.

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Calculating how much car you can afford

Set a monthly budget

Before buying a vehicle, it's crucial to establish a budget to determine how much you can afford to spend monthly on an auto payment. However, Roosenberg advises that this number should be viewed as a guideline rather than a goal, as frugal spenders can still find a much cheaper vehicle.

Roosenberg advised that in addition to considering your current budget, you should also take into account your future budget when making a long-term financial agreement. He emphasized the importance of projecting what you will be able to do financially in the next four to six years and determining if you will be comfortable with making that level of commitment.

Roosenberg recommends spending no more than 20% of your post-tax monthly income on your car payment, but this number can vary depending on your state's cost of living and your outstanding debt.

If you earn $5,000 monthly, you shouldn't solely focus on cars with a $1,000 monthly payment. Instead, consider the limit and look for the most affordable car that meets your requirements.

Before making a significant investment in a car, ensure that your financial situation is stable. Following the 50-30-20 budgeting rule can help you manage your money effectively. For instance, it may not be wise to purchase an expensive car if you are not saving enough for retirement or do not have an emergency fund.

Goodbudget is a budgeting app that simplifies tracking your expenses by dividing your cash into various spending categories, with each category represented by an envelope. For instance, you could use an envelope for your monthly car payment.

Financing a car vs. paying in cash

An auto loan and paying for a car in cash have several differences. A 2023 study from CDK Global found that 29% of people surveyed purchased their latest vehicle in cash.

Financing a car with cash eliminates interest costs, which can accumulate to thousands of dollars over the life of a loan. For instance, if you put $5,000 (20%) down on a $25,000 car and financed the remaining $20,000 at 5% for 48 months, you would end up paying over $2,100 in interest charges. Additionally, paying in cash allows you to own the car instantly and add it to your financial portfolio as an asset.

Financing a car may have lower initial expenses, consisting of a down payment and any fees charged by the dealer. However, financing a car involves interest costs and any additional fees associated with the loan, such as lender's fees. According to L.A. Financial Credit Union, dealer fees can amount to up to 10% of the vehicle's cost. These fees will be included in the loan amount, and you will pay off the total amount over the loan term.

Factor in additional expenses

Roosenberg notes that cars are expensive, depreciating investments, as interest rates have increased since their lows in 2020 and 2021, and the cost of vehicles has also risen since the pandemic.

While used cars may have lower list prices and monthly payments compared to new cars, it's crucial to consider the potential future maintenance costs before making a purchase. Experian advises that it might not be worth getting the cheapest, oldest car on the lot just to save money upfront. Additionally, it's essential to factor in other expenses, such as car insurance premiums and gas, when creating a budget.

Roosenberg states that you won't be able to determine the rate, total amount borrowed, or term until you receive a contract offer.

Use a loan calculator

To estimate monthly payment estimates before committing to a car loan, CNBC Make It provides a convenient loan calculator. This tool simplifies the process of determining whether a car loan fits within your budget, eliminating the need to create an amortization schedule manually. Remember to subtract your down payment from the list price of the car to determine your total loan amount.

How to affordably finance a car

Consider these top auto lenders

Purchasing a car with an auto loan involves borrowing money and repaying it with fixed installments over a specified timeframe, typically ranging from 2 to 7 years. The loans can be obtained from various sources, including dealerships, banks, credit unions, or online lenders.

Instead of financing with a dealer, which may have the highest interest rates, consider using one of CNBC Select's top-rated auto lenders and shop around for the best terms and lowest interest rate.

One of our top picks for auto loan lenders is PenFed Auto Loans, which offers affordable rates and flexible loans. You can prequalify for a loan and see estimated terms without a hard credit check.

If you're not interested in joining a credit union, CapitalOne Auto Finance offers the option to prequalify and check estimated terms without a hard credit pull. This allows you to shop around for competitive rates and explore car offers without stress.

If you're looking for car loan rates and don't want to fill out multiple applications, MyAutoloan is worth considering. They'll match you with up to four prequalified loan offers after you fill out a quick form.

Just like any other loan, reducing your down payment and extending your loan term will increase the interest charges you'll pay over the life of the loan. On the other hand, paying off your debt too quickly can lead to financial difficulties in meeting other ongoing expenses.

Take advantage of car insurance discounts

Car insurance is one of the biggest expenses associated with owning a vehicle, according to Roosenberg.

Saving money on car insurance can be achieved by taking advantage of the discounts offered by insurance companies. These discounts include those for safe driving and bundling home and auto insurance. Additionally, having a high credit score can lead to a lower car insurance rate and a better loan interest rate.

Geico offers competitive premiums for full coverage car insurance and has 16 different types of discounts available, consistently receiving high ratings for customer satisfaction.

Other tips to save

To save money, consider buying a lightly used car from multiple dealerships, taking advantage of trade-in offers for your old car, and carefully reading and understanding the loan terms to negotiate features such as interest rate and down payment.

Roosenberg states that consumers are conducting more research before visiting dealers than ever before, based on his studies. As a result, he recommends going online to compare prices.

Knowing a car's true market value can aid in negotiating with dealers and determining when to walk away, as stated by Consumer Reports. Kelley Blue Book is a widely used resource for comparing sales prices of specific makes and models.

One common mistake consumers make during the car-buying process is unintentionally disclosing their financial information to dealers. Instead of revealing your monthly budget to a dealer, it's crucial to first determine your budget and then negotiate the vehicle's price to ensure it falls within your range.

Bottom line

Roosenberg emphasizes that while formulas can provide a general guideline, the ultimate question is: What can you afford?

Before buying a car, research loan packages and insurance premiums to avoid overspending.

Meet our experts

At CNBC Select, we collaborate with experts who possess specialized knowledge and authority through relevant training and experience. For this report, we spoke with Patrick Roosenberg, the senior director of automotive finance intelligence at J.D. Power. With over twenty-five years of experience in automotive finance, Patrick has worked with major banks and captive lenders, and has studied dealer-lender and consumer-lender relationships.

Why trust CNBC Select?

Our goal at CNBC Select is to deliver top-notch service journalism and in-depth consumer advice to our readers, enabling them to make well-informed decisions when it comes to their finances. Each of our personal finance guides is the result of thorough reporting by our team of expert writers and editors, who possess extensive knowledge of personal finance products. At CNBC Select, we are committed to maintaining our journalistic standards and ethics, even when we earn a commission from our affiliate partners on many offers and links.

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