Standard affordability rules are ‘impossible’ due to rising car payments

As auto prices and payments rise, it is increasingly difficult for people to rely on the traditional rules of thumb that were used to calculate how much they can afford to pay in auto payments.

Saijal Patel (founder and chief executive of Saij Elle personal finance company) stated that “we have so many people relying upon rules of thumb and it is impossible to use them.” Yahoo Finance Canada In a phone interview.

“It’s dangerous in my view to use them because it requires you to place it all in context.”

The personal finance world has a long-standing rule that vehicle expenses should not exceed 10% to 15% of your gross salary.

A common affordability rule in buying a vehicle includes the 20/4/10 method. It requires a downpayment of no less than 20%, a maximum term of four years for the car loan, and a monthly payment of not more than 10% of your weekly take-home income.

Patel said that reality is often more complicated than the rules. Because of this, it’s important to take a closer look at an individual’s financial situation before determining affordability.

She said, “I would not advise anyone to buy a car without first understanding their whole income, expenditure picture, and all other goals and needs.”

“My point is rule of thumbs – 9/10 don’t work. You must prioritize and plan for every situation.

According to Finder.com personal finance comparison website, Canadians spend an average of $400-$800 per month on their car payments. The average monthly payment for new vehicles is higher than the lower end. When you add in maintenance/repair, gas, insurance, and insurance, the cost of new vehicles quickly balloons. This is easily beyond traditional car affordability guidelines.

Patel gives the example of a $45,000 vehicle purchase plus tax with a 20% downpayment. A monthly payment of $940 for a four-year loan with three percent interest would be required. Add $500 for maintenance, insurance, gas, and fuel, and you get $1,440 monthly.

The vehicle would consume 34% of an individual’s monthly income of $72,000 or approximately $4,273 after tax.

“Those numbers are real. You have rent, food and retirement savings. How do you make ends meet? Patel stated.

She said that clients should add up their monthly net earnings and fix expenses in order to calculate how much money they might have to contribute to a car.

How to Save on Car Payments

Patel advises that buyers can save more money on the downpayment or extend the loan for a longer period of time, particularly if the vehicle is essential.

Patel cautions buyers against buying promotional financing from dealerships, which may include zero percent financing or no payments over a period of time.

You can find out more about dealer financing options by reading the fine print. This will help you understand the interest rate and avoid unnecessary fees.

“Dealer are trying to attract new customers by being creative,” said Romana King, senior finance editor at Finder via e-mail. One popular promotion is the 0% financing offer. Romana King, senior finance editor for Finder, said via e-mail that interest-free loans don’t make sense if you are constantly juggling bills and can’t afford to pay higher-interest debt.

A financing promotion may be an option for those who pay their bills on time and are able to repay loans quickly.

She stated, “Just make certain you’ve done the math and are sure you can repay the loan (or a large part of it) within the promotional time to avoid heavy interest charges (and keep your monthly payments lower).”

King recommends that you arrange financing before you visit a car lot.

Buyers may also be able to search for vehicle models that are no longer in fashion.

“While inventory was scarce over the past few years, there were always makes or models that are in high demand.” These out-of-favour models can be purchased at a lower price if you don’t want to hold onto just one or two models.

Michelle Zadikian works as a senior reporter for Yahoo Finance Canada. Follow her Twitter @m_zadikian.

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