Updated: Oct 22, 2018
“How much car can I afford”? This is the question I most often hear when my clients are in the car buying process. My response is always the same, “You are asking the wrong question.” “How much car can I afford?”, is a very dangerous question and if you ever ask it at the dealership, you will most likely drive off the lot with a car you absolutely can’t afford. The question you should be asking is “What am I willing to spend on a car?”. This question puts you in the driver’s seat (no pun intended) and allows you to take a step back and really evaluate the question. Now that you are asking the right questions I will take you through my 3-Step car buying evaluation. This 3-Step process will give you all the tools you need to make the perfect car buying decision for you!
Step 1: Do you really need a car?
This step is vital, and for some folks, this is the only step they need to take. Before going out and buying a car because you can afford one or because your old one broke down, take a second to ask yourself if you really need one. Where do you travel from day to day? Is there a public transportation option? Would it be cheaper to ride share? Most people don’t ask themselves this critical question nor evaluate the other expenses that a car purchase will cause. A car comes with expenses like gas, insurance, parking cost, city stickers, plate stickers, oil changes, etc.! For most people, if you step back and do the math you might be a lot better off not buying a car.
Step 2: Never Buy A New Car
In personal finance, there are very few straightforward answers, and I very rarely use the word “never.” However, in my opinion, you should never buy a car brand new. Why? Well, there is this mystical concept called depreciation. Deprecation is the reduction of the value of an asset over time and very few assets depreciate faster than cars. On average, new cars lose 10% of their value once you drive off the lot. So, if you purchased a $40,000 car and drove around the block and tried to sell it back to the dealer it would only be worth $36,000. That’s insane! Most cars lose 40-50% of their value after the first 3 years so unless you plan on keeping that car for its entire useful life, it’s a bad investment.
Step 3: Understand What A Car Means to You
If you don’t care for cars and just need something to get you to work and back, then I would advise you spend as least as possible (hopefully purchase will cash) and go about your day. On the other hand, if you define your social status by the car you drive then I would have a different recommendation. Understanding what a car means to you is very powerful and plays a big role in what you are willing to spend. Generally, I recommend that no one spend more than 30% of their salary on a car. This comes out to about $6,000 for every $20,000 in salary. So if you make a $100,000 you should spend no more than $30,000 on a car. The reason I don’t like solely using this rule of thumb is that it doesn’t consider the outside factors. Just because you make $100,000 doesn’t mean you need a car at all, let alone need a car costing $30,000. You may be better off buying a $10,000 car with cash and never ever having a car note. Wouldn’t that be great?!
So next time you are thinking of buying a car, take yourself through this 3-Step process. It will allow you to effectively select a car that is right for you… or help you not buy a car in the first place. Vehicle costs are American’s third largest expense behind school cost and home ownership. Making an educated decision in this area could save you thousands over the long term.