Once youve earned it, many might imagine, you should be able to spend it any way you want. Who has the right to tell you that paying $1,000 a month or more for a car payment is a bad idea when you want to spend that much?
Spoiler alert: Im about to tell you, its not a good idea for many people. Its really not.
Just four years ago, only 4. Two percent of customers who financed a new car in the first quarter of 2019 signed the dotted line and agreed to pay $1,000 or more a month for the car loan on a new car, SUV, or truck, according to Edmunds data.
Flash forward. During the first quarter this year, that number has jumped up to 16. Eight percent (20%)20%E2%80%94%20a record 11% out of 6 buyers (20%)20%E2%80%94%20who committed to a monthly payment of $1,000 or more, according to Edmunds We were looking at 10. 3% in the first three months last year making such high payments, up from 6. 2% in the first quarter of 2021 and 5. 2% in the first quarter of 2020.
Its shocking to see the steady growth in astronomical payments. Did families simply give up the second car now that some people work from home in favor of putting everything on one opulent truck or SUV? After all, the majority of us don’t feel that much wealthier than we did before the pandemic, do we?
It’s a good idea to think about how you divide your paycheck between housing, transportation, and other necessities and, yes, wants as April is National Financial Literacy Month. Spending too much on one thing can vastly cut into what youre able to use toward something else.
Higher car prices and higher interest rates are driving up what many, though, are spending toward car payments.
According to Edmunds, the average monthly payment for new cars, trucks, and SUVs reached a record $730 in the first quarter, up from $656 at the same time last year. Put another way, new buyers ended up paying an extra $74 a month on average — up 11. 3% — than just a year ago.
The average new vehicle was financed for 68. 8 months, or over five and a half years, in the current year’s first quarter, per Edmunds data. Thats down from 69. 8 months for the same time a year ago.
The average payments are mind-boggling, too. It’s not like you can buy a car for $700 a month for six years and then have free and clear ownership of it for twenty years.
In today’s world, cars are more than just a mode of transportation; they’re a symbol of freedom, independence, and even status. But with rising car prices and interest rates, many people are finding themselves drowning in a sea of car debt. So, how much car debt is too much? And how can you manage your auto loan responsibly?
This comprehensive guide will delve into the intricacies of car debt, helping you determine what’s manageable and providing tips for staying afloat financially.
Understanding the 10-20-40 Rule
Financial experts recommend adhering to the 10-20-40 rule when budgeting for your car. This rule suggests allocating:
- 10% of your net monthly income towards your car payment.
- 20% of your net monthly income towards total car costs, including insurance, gas, maintenance, and the payment itself.
- 40% of your net monthly income towards essential needs like housing and food.
- 30% of your net monthly income towards discretionary spending like entertainment and travel.
While this rule provides a general guideline, remember that it’s flexible You can adjust the percentages based on your individual circumstances and financial goals
Analyzing the Current Landscape
With a record 16 months of payments, the average monthly car payment for new cars has reached an astounding $730. 8% of buyers committing to payments exceeding $1,000 per month. This trend is alarming because it shows that a lot of people are straining their finances to buy cars that are getting more and more expensive.
However, it’s important to remember that the 10-20-40 rule is just a starting point. If you have a higher income or fewer financial obligations, you may be able to afford a higher car payment. Conversely, if you have a tight budget or significant debt, you may need to opt for a more affordable car.
Calculating Your Ideal Car Payment
Several factors influence your ideal car payment, including:
- Loan amount: The amount of money you borrow to purchase the car.
- Loan term: The length of time you have to repay the loan.
- Annual percentage rate (APR): The interest rate on the loan, including the interest rate and any lender fees.
Based on these variables, you can use a car loan calculator to determine your estimated monthly payment. With the aid of this tool, you can ascertain how much you can actually afford and prevent overextending your financial situation.
Strategies for Managing Your Car Debt
If you find yourself struggling with car debt, there are several strategies you can employ to get back on track:
- Refinance your loan: If your credit score has improved since you took out the loan, you may be able to refinance to a lower interest rate, reducing your monthly payment.
- Make extra payments: Even small extra payments can significantly reduce the amount of interest you pay over the life of the loan.
- Sell your car and buy a cheaper one: This may be a drastic step, but it can free up significant cash flow that you can use to pay down debt or save for other financial goals.
- Consolidate your debt: If you have multiple debts, consolidating them into one loan can simplify your repayment process and potentially reduce your interest rate.
Additional Resources
For further guidance on managing your car debt, consider these resources:
- NerdWallet: This website provides comprehensive information on car loans, including calculators, articles, and tips.
- The National Foundation for Credit Counseling: This non-profit organization offers free credit counseling and debt management services.
- Your local credit union: Credit unions often offer lower interest rates on car loans than traditional banks.
Managing car debt responsibly requires careful planning and budgeting. You can manage your car payments and stay out of debt trap by researching different strategies, evaluating your current financial status, and comprehending the 10-20-40 rule. Recall that although a car is an important asset, your financial security should never be sacrificed for it.
The risks go up for those on tight budgets
Since most people need a car to get to work, many will do whatever it takes to make the car payment. Nonetheless, individuals with lower incomes are more likely to miss a significant auto payment.
Trent Graham, a program performance and quality assurance specialist at Farmington Hills-based nonprofit GreenPath Financial Wellness, said, “Since the pandemic, ongoing inflation has squeezed household budgets.”
“Interest rates on auto loans have gone up. Personal savings have dwindled. COVID federal aid is no longer available. Credit card use is at all-time highs. “.
According to him, each of those elements makes it harder for some borrowers to make their auto loan payments on time.
For instance, he stated that clients at GreenPath Financial Wellness who were in debt and earning less than the median income in their local area were twice as likely to fall behind on an auto loan in the first quarter of this year as compared to those who made the median income or more.
Graham reported that 226 percent of the nationwide clients counseled at GreenPath who earn half or less of their region’s median income (E2%80%99) were delinquent on their auto loans in the first quarter. That’s actually lower than the percentage that was 3% for the same period a year ago for a group of clients in that similar income range.
According to the federal Department of Housing and Urban Development, the median family income for a family of four in the metro Detroit statistical area is $89,800. Those falling into the 25%050% or lower category would be a family of four earning at least $44,750 annually.
The average monthly car payment for debt-ridden clients seeking assistance from GreenPath nationwide was $459 during the first quarter of this year.
According to Graham, a good rule of thumb is that anything over 30% of monthly net income is simply too much to devote to a car payment and other various expenses associated with car ownership.
The top range could be 25%, he said. If an individual earns $2,500 monthly after taxes, or $30,000 annually after taxes, they could be able to allocate $625 per month towards their overall transportation costs. However, it’s important to note that this amount does not include other expenses such as gas, license plates, insurance, and car loan payments.
“Add all of the monthly costs and then you will see your total transportation costs,” Graham said.
How much of your money should go toward wheels?
Ideally, you should not have to pay off a car loan with a week or more of your monthly income.
A good ballpark range is that you should aim to spend no more than 15% to 20% of your income on all transportation costs — and that includes insurance, parking, maintenance, gas to put in the tank, and monthly payments.
Although every situation is different, I think there’s a good general guideline for an individual or household to aim for when it comes to saving 15% of their monthly net income to put toward their overall monthly transportation expenses. This was stated by Mark Munzenberger, the manager of financial education for the University of Michigan Credit Union.
Net income is your take-home pay or after taxes are taken out of your regular check.
Many families, of course, need more than one car. Two wage earners, for example, could have to travel in opposite directions each day to work. Students in high school and college who live at home may require a car in order to get to activities, jobs, and classes.
Munzenberger added that it’s a good idea to consistently save money for major future expenses like new tires and brakes.
Should you fail to adhere to recommended guidelines for a sound budget, you may find yourself in a tight spot financially in other areas.
Given that the average annual interest rate on credit cards is 20, the last thing you want to do is start using expensive credit cards to pay for regular expenses. 11% — up from an average of 16. 36% a year ago, according to Bankrate. com data.
You won’t be able to save as much money for larger objectives, like a down payment on a house mortgage or creating a nest egg for retirement, if you don’t set a limit on your car payment expenses.
A large monthly car payment (%22A%) may only enable an individual to save 3% to 5% of their monthly 401(k) contributions, in contrast to 8% to 10% of the total. Over time, that makes a huge difference,” Munzenberger said.
How Much Car Is Too Much?
FAQ
What is considered a high car payment?
How much does the average person owe on a car?
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Average Auto Loan Balance by State
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State
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2022
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2023
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California
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$23,268
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$24,925
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Colorado
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$23,228
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$24,322
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Connecticut
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$18,491
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$19,480
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Is $500 a month a high car payment?
Is $400 a month too much for a car?
Why is auto debt growing so much?
This is happening as total auto loan debt held by Americans has increased dramatically over the past 10 years, surpassing $1.4 trillion—more than the gross domestic product of Australia. Because of recently skyrocketing prices for new and used cars, that debt is likely to grow even more.
How much is too much for a car payment?
Additionally, it’s advisable to allocate no more than **15% to 20%** of your income for **total car costs**, including gas, insurance, and maintenance, in addition to the payment itself
How much a car loan if you have no credit card debt?
If you are in the fortunate position of having no credit card debt and no other liabilities and are also thinking about buying a new car to get around town, you can take on a car loan of about $17,500 (assuming an interest rate of 5% on the car loan, repayable over five years).
Why is auto loan debt at a historic high?
One of the key reasons auto loan debt is at a historic high is that “car prices have increased in recent years, so consumers are taking out bigger loans and often for longer terms,” said Caleb Cook, vice president of consumer lending at Digital Federal Credit Union, via email.