$1000 Car Payments are now a new normal according to headlines, with more than 15 percent of new-vehicle buyers signing on for four-figure payments.

Now a lot of car dealerships will try to convince you that you can afford much more of a car than you actually can - because these days the average car loan term is over 69 months. And based on the data, if your credit score is lower, the more likely you are to take on an even longer car loan term. Not only that, car loan interest rates are getting higher, that means having a car payment these days is going to be A LOT more expensive than in times before.

We’re gonna cover a couple of car buying rules in today’s article, cover if financing or leasing is better for you, some car buying tips, and I’ll give you specific numbers on the 3 salary ranges I talked about earlier.

The 35% Rule states that the most you spend on the price of a car is not to exceed 35% of your gross income.

That means if you make $40,000 a year, the car’s price should not be higher than $14,000 (35%) If you Make $80,000, the car’s price should be below $28,000, and at $150,000 that means your max car price should be $52,500.

Now in reality this 35% Rule is pretty aggressive and recommended for car enthusiasts - those that want to spend a pretty penny on their car, and take enormous pride in what kind of car they drive.

If you want just a basic car that takes you from point A to point B, you want to be even more conservative and frugal, so perhaps you spend less than 20% of your gross annual income on a car. If you want something in the middle, perhaps 25% is the sweet spot.

The 25% sweet spot is my personal favorite because as long as you stay within this guideline, the car payments you will make should be affordable.

So if you take away one thing from this video, just remember the 25% number - because overall I think it’s a better gauge of affordability than 35%.

When you’re looking to buy a car, you should try to focus on the actual purchase price of the car, rather than the monthly payments - because at the end of the day, what you will be paying for your car in the big picture is all that really matters.

In terms of car affordability when you are buying, there’s a popular rule called the 20/4/10 rule.

The first part of this rule is that it recommends making a 20% down payment on the car. So if you’re trying to buy a car that’s say $30,000 - you would put $6000 dollars down.

The reason you want to put down a 20% down payment is that it’ll be much easier to handle the loan over time with your payments, and having 20% on hand ensures that you are in a financially responsible position to actually take on this purchase.

If you finance 100% of the car, as in, you make no down payment - you end up getting into a precarious position.

Here’s an oversimplified example:

Let's say you buy a car for $25,000 and finance the entire amount - you owe $25,000.

After one year, the car depreciates in value by 20%, which is pretty common for new cars by the way - which means that your car is now worth $20,000.

So now if you want to sell the car, you’re only getting $20k for it - and you still owe roughly $25,000 on the loan - that means you would sell the car but still owe $5k. That means you’re underwater on the car itself.

Making a 20% down payment will help you avoid being underwater, because it lowers the amount you have to finance, and you start building equity in the car much faster. That means if you need to sell or trade the car in before the loan ends, you’re less likely to owe more than the car is worth.

This is also one of the biggest cost of cars, as I mention in my Wealth Killer video - depreciation is killer, you’re constantly putting money into an asset that is going down in value over time. So a good option is to instead get a used car where most of the depreciation has been chipped away after 3-5 years already.

The next part of this rule is the “4” - this is saying that you should get a car loan that has a maxmium term of 4 years.

Four years is a reasonable time because it’ll keep the monthly payments manageable and prioritizes paying off the car fast enough before the car depreciates too much.

Also, if you push out your loan term to 5, 6, or even 7 years - what actually ends up happening is that it ends up costing you more in interest over time.

You can see that on the image on the left here, if you are financing a car for 4 years that costs $30,000 - your total interest paid is $2529. However if you finance it for 6 years - that total interest is now $3829. Thats over $1300 dollars you are just throwing away to interest.

Calculator: https://www.thebalancemoney.com/how-much-car-can-you-afford-4156674

I think a problem that many people run into in America and other countries where auto loans are prevalent these days is that often times the car buying rules such as the 20-4-10 rule make it so that we can’t really afford the car we think we deserve.

There’s a lot of societal pressures to buy a new car to keep up with others, and I mean, look at the calculators. With a 4 year term, you need to fork out $552 a month for the same car that costs $386 a month for 6 years.

So you could have two people, one drives a society “cool” BMW that costs $550 a month, but then you have someone else driving a Honda civic and their car payment could be $550 a month as well. But the thing is - the term is different.

Many people get longer car loan terms to get a status car, or a car that’s out of their actual affordability budget.

The last part of the 20-4-10 Rule is arguably the most important. 

The 10 refers to the fact that you should aim to keep your monthly car payment, including insurance and maintenance under 10% of your gross monthly income. Note that this rule does NOT include fuel costs, although you should always factor that in as well.

Here’s a table of incomes between $40k and $150,000 and how much of a car payment you can afford. An easy rule of thumb is to simply take your annual gross salary and divide it by 120, and you’ll get the max monthly car payment you can afford.

Looking at our notable salary ranges, if you make $40k you can afford a $333 dollar car payment including maintenance and insurance, at $80k thats $666 dollars, and at $150k it’ll be $1250 per month.

Now just because you can afford something, does that mean you should max out your car payment based on these guidelines? Hell no, be prudent - because cars are depreciating assets and if you watched the Wealth Killer video on my channel you’ll know exactly why cars can really hurt your compounding of wealth.

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Lower = better, save It for investing etc

Now you’re probably wondering, why is it 10% of your monthly income? Why not 15% or 20%? The PURPOSE is that It’ll help you not overspend on a car. We want to ensure we have enough money to cover any financial issues down the line - and limiting your car expenses to less than 10% of your monthly gross income is a great financial guideline.

Ok a big question is - should you Buy a car or lease a car? And if you are buying, finance or pay with cash?

Let’s cover the leasing portion first. Leasing usually makes sense if you are someone looking to drive a new car every 3 years or so, or if you want a lower monthly payment.

If this is the case, you're better off leasing, compared to buying.

Pros also include a low down payment (zero is usually best), warranty coverage, and in some situations you can write off the lease payments if you are a business owner. The cons include the fact that there are mileage limits, and the fact that its not your car by the end of 3 years.

In some situations, leasing might be the best financial decision, but if you plan to keep a car for a longer time, then buying is going to make more fiscal sense.

When it comes to buying a car, we can either pay for it all in cash or we can finance.

If you’re someone who values not having a car payment and peace of mind, or if you’re able to get a discount on the total price of the car by paying in full, that could be interesting.

Also, if you have cash thats not invested and you dont plan on investing, you may just want to use that for a car and not pay interest charges - I get that. However, I do think that if you are watching my channel, most of you guys are investors… and thats why financing makes usually more sense when it comes to buying a car, provided you’re comfortable with having a car payment.

The reason is the opportunity cost of the cash.

Pretend you paid $25k up front for a new car, thats $25k you don’t have to invest and compound your wealth.

Instead, let’s pretend you put 20% down, so $5k. That would still leave $20,000 cash in hand that you can invest.

If you took the $20,000 and invested it into the S&P 500 which averages about 9-10% per year, it could become $31,000 in 5 years. Or similarly, if you’re thinking about retirement, that money could become $265,000 dollars in 30 years.

Of course, no one operates perfectly with their opportunity cost decisions, and theres always expenses that we won’t account for - but in general that’s why financing makes more sense than paying all cash up front.

The first tip, which is what I shared in the Wealth Killer video - is to call around and shop for car insurance. Many places will provide similar if not the exact same coverage, and often times these companies will try to undercut each other and you can get a better deal by shopping around with competitors - this is an easy way to save a lot of money.

The second tip is to buy a used car! The sweet spot for a used car is after 3 years of depreciation, and often times a 3 year used car will still feel ultra new. That way you’re not losing a bunch of money to depreciation.

My third tip is to get a car that isn’t expensive to maintain over time. Edmunds has a calculator called the True Cost to Own calculator that I used in my Wealth Killer video, and sometimes more luxury cars might cost you way more in maintenance than you originally thought. Looking at this 2017 BMW X5 versus a 2017 Toyota 4 Runner, you can see that the total cash price for the BMW is actually cheaper than the Toyota, but ends up costing you over $20k more to own than the 4Runner over 5 years because of maintenance, insurance, and repairs.

Okay so I think after watching this video, you may feel a little sad about how much of a car you can actually afford - but the reality is that most people are driving cars they can’t afford in America. The average price paid for a new vehicle in the United States in October 2022 was $48,281, that means if we were using the more aggressive 35% rule - the average gross salary of all these people buying cars should be $137,945 - which, is definitely super far from the average salary of in the US.

If you’re able to afford a car and use the 20/4/10 rule or the 25% rule, congrats because that is really amazing and you should feel good about that.