How to Accurately Estimate Your Car Budget

The first step in the car buying process is figuring out your budget, which is where many car buyers make their first mistake. The problem is that many people simply assume how much money they can spend instead of calculating the actual amount, which leads to overspending. To avoid this, you need to consider each and every aspect of vehicle ownership and then fit it seamlessly into your personal budget. Here is how you can do that.

Step #1: Determine All Your Monthly Expenses

Assemble copies of all your latest credit card statements and bills, including your mortgage, utility, internet and cell phone numbers. After that, list all the monthly payments in a spreadsheet and divide them into two categories – fixed and variable. Fixed expenses should include payments that stay the same each month, like mortgage, utility, internet and television, while variable expenses should contain the ones that can change, like groceries and clothes.

Once your lists are complete, add up the amounts to obtain totals for each column and then add those to find out your total expenses.

Step #2: Calculate Your Disposable Income

Calculate your monthly household income and then subtract your total expenses from this amount. You should then decide how much of this disposable income you can part with each month. It is always a good idea to have some money left for emergencies, savings account and, of course, fun. A good rule of thumb is to spend no more than 10 per cent of your monthly household income on a single vehicle. Ultimately, however, the amount you spend on a vehicle will depend squarely on the size of your other expenses.

Step #3: Estimate Your Ownership Costs

Once you know how much money you can afford to spend on a car per month, you should estimate how much you are actually going to spend. Car ownership costs tend to include expenses such as financing, insurance, maintenance, fuel and depreciation. According to CAA.ca, an average compact costs $9,500 to own, which amounts to roughly $790 per month. The biggest part of the cost is depreciation, followed by fuel, interest and then insurance. Use this amount to ballpark your monthly expenses, but keep in mind that your exact expenses will ultimately depend on your selected vehicle and how often you are planning to drive. You can find more information on calculating ownership costs here.

Step #4: Figure Out the Price of Your Vehicle

After estimating your monthly car ownership expenses, you should figure out the approximate price of your vehicle. You can then use it as one of the parameters to limit your vehicle search.

Since car loans last for three to six years, it is possible to afford a very wide range of vehicles. For instance, if your monthly car budget is $550, then you can obtain a loan ranging from $15,000 for 36 months to $32,000 for 84 months, which is essentially the difference between a Honda Civic and an Audi A3.

While a longer loan can net you a more expensive vehicle, it can also force you to spend more on interest. Financial institutions charge interest for each monthly payment, which is why longer loans add up to more interest.

Longer loan payments are also problematic for people who want to own a vehicle for three years or less since they would have to trade it in before paying off the loan. By the time you are ready to trade in your car, it may be worth less than what you owe for it. In this case, a trade-in would not provide you with enough money to pay off your loan.

On top of everything, expensive vehicles tend to have higher ownership costs since they are more costly to insure, maintain and repair. According to CAA.ca, a compact car, such as the Honda Civic, can cost $9,207 annually, while a full-size luxury vehicle, like the Chrysler 300, can cost $12,776. If you buy the former, you can easily save thousands of dollars.

You can always treat yourself to a more expensive vehicle, but you should keep the cost discrepancy in mind.

Step #5: Cut Certain Expenses (if Necessary)

If you are unable to devote as much money to a new car as you would like, you may want to reduce certain expenses. The fastest way to achieve this is by entering your income and expenses into some form of budgeting software, such as Quicken. It should then show you where you tend to overspend and suggest new amounts. For instance, if you are spending 20 per cent of your income on entertainment, the software may recommend that you spend five per cent instead.

So, if your variable expenses are above the recommended levels, then you should probably lower them. Establish specific target amounts for those variable expenses. For instance, if your entertainment budget is $500, set $150 as your goal. You may also want to spend less on lunches and other little things. If you can make a few sacrifices here and there, then do not hesitate to do so.

Step #6: Consider Future Expenditures

The longer the car loan, the more aware you have to be of your potential financial situation in the future. Due to a wide variety of reasons, many of your expenses, such as rent, will undoubtedly increase over the years, which means that you may not be able to afford them anymore. The best way to avoid such an uncomfortable situation is by taking a look at all your bills and figure out how much they will be worth a few years down the road. Take into account other additional expenditures that may arise, such as mortgage, buying new furniture or having a baby. All of these can offset your budget in a negative way and cut into your disposable income.

What to Do Next

Once you are done creating your budget, the next step is to select your vehicle type.

Have a Car in Mind? See the latest incentives, rates and rebates now!

Updated on March 26, 2013

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