Deciding on a Car Budget
Any time you’re planning to make a big purchase, you need to go in with a plan and a budget. This is especially important when purchasing a vehicle. You need to have a firm understanding of how much you can afford for a car. Having a budget will dictate whether you buy a new or used car, a base model or an upgraded model and how long of a term you agree to. In this article, we’ll talk about exactly what you need to factor in when making a budget to buy a car in Canada.
5 Factors That Affect Car Financing
Credit Score: Your credit score is one of the most important factors in the type of financing you get approved for. The better your credit score, the more trusting the lenders will be of you, getting you more favourable loan conditions.
Down Payment Amount: The amount you put as a down payment will directly affect your monthly payments and potentially get you a lower interest rate because you’re asking the lender for less money.
Loan Term Length: The loan term length is how long it will take you to pay off the loan. The longer the term, the smaller the monthly payments but the higher the interest rate. Ideally, you agree to the shortest loan term possible to keep interest rates minimal.
Sales Tax: While the sales tax varies from province to province, this could play a big factor in what you can afford to pay for a car.
The Interest Rate: While this goes hand in hand with your credit score, the lower the interest rate, the more you’ll be able to afford.
The 20/4/10 Rule
The 20/4/10 rule is a ratio that Ratehub came up with to help Canadians with budgeting for a car. It’s broken down into three components, the down payment, the term length and the monthly payments.
Down Payment on the Car Should be 20% of the Sticker Price
Most automotive experts agree that when buying a car, you should put down at least 20% of the car’s sticker price as a down payment. The reason for this number is not arbitrary, but because the car will most likely depreciate by 20% in its first year of ownership or more if it’s a brand new car. Putting less than 20% as a down payment puts you at risk of being in an upside-down loan where you owe more than the car’s overall value. This is especially likely if you’ve agreed on a long-term loan.
Limit Your Car Loan to 4 Years
The longer your car loan term, the more interest you’ll end up paying. When you’re looking for a car loan you should aim to get the shortest loan term length you can afford so you can minimize the amount of interest you’ll pay. Most experts agree that a 4-year car loan term is the ideal length to keep interest rates down and monthly payments feasible.
The other factor that may come into play when opting for a shorter-term loan is that the lender may require you to pay more for insurance in order to protect their asset. Once you’ve fully paid off the vehicle, you should be able to find another insurance plan should you find one that’s more affordable.
Keep Your Monthly Payments Below 10-15% of Your Total Income
In order to get a great car that you can afford to make monthly payments on, it’s recommended that your payments are under 10-15% of your total earnings after tax.
Using a Car Loan Calculator
One of the most valuable tools you can use to accurately understand how much you can afford for a car is a car loan calculator. A car loan calculator incorporates the sticker price of the car, the length of the term, the interest rate on the loan, the province you’re in, the down payment made and the trade-in value if you decide to trade in your vehicle. At the end of plugging in all of these numbers, you’ll be presented with what you’re monthly payments will be.
Incorporating Other Car Expenses
Now that you have a better understanding of what you can afford, you need to think about the additional costs of owning a car.
Fuel Costs: Unless you decide to buy an electric car, there’s no avoiding paying for fuel. Do your best to estimate how much you’ll drive monthly and what that will cost you in fuel. This could also dictate the vehicle you buy as some cars are much more fuel-efficient than others.
Vehicle Add-ons: When buying from a dealership, the lowest price you’ll see for a vehicle is usually the base model with standard features. If you need an upgraded feature or customization on the vehicle, you need to expect to pay for that and incorporate that into your budget. This also goes the other way because you may be able to opt-out of certain features in exchange for a price reduction.
Extended Warranties: When buying from a dealership it’s almost guaranteed that you’ll get offered an extended warranty and this may be something worth considering. While most people don’t end up having to use their extended warranty, it could be helpful in case you need a major repair. It also gives you the peace of mind to know that if something were to happen to the vehicle that you’re covered.
Maintenance Costs: If you want your car to last a long time you need to take good care of it. This means getting regular oil changes, swapping your seasonal tires and getting the car checked out if the engine light comes on. Keep some of your budget aside so you can afford these things when they’re needed.
Repairs: Eventually, your vehicle is going to need some level of repairs and this can get expensive. Therefore, it’s a smart move to put some money aside or pay for an extended warranty so that you’re not in a bad position if a repair is needed.
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