Though mortgage lenders typically set clear guidelines for the percentage of income you can spend on your mortgage, no such guidelines exist for car loans. To determine how much of your income you should spend on a car, you must consider your total debt and personal circumstance. You might also consider how much of your income will go to car maintenance, fuel and insurance.
Gross Income Ratio
One way to decide how much to spend on your car is to calculate the percentage of your gross income used to pay debts. To calculate this percentage, divide your revolving monthly debts by your gross monthly income. Revolving debts include mortgage payments or rent, credit cards and other loan payments. For example, if your monthly payments equal $600 and your gross monthly income is $2,400, then your ratio is 25 percent (600 divided by 2,400). According to Consumer Reports, your revolving debts, including car loans, should not exceed 36 percent of your gross income.
Another method you can use to estimate a safe car payment involves totaling your revolving debts minus your mortgage and dividing them by your after-tax income. The result is your debt-to-income ratio. For example, if your revolving debts equal $300 and your after-tax income is $3,000, then your debt-to-income ratio is 10 percent. According to MSN Autos, this ratio should not exceed 15 percent after you include your car payment.
Some experts believe that you should also consider all the costs associated with ownership when determining how much to pay for your car. For example, the College Board budget for new graduates suggests that your car payment, insurance, gasoline and maintenance should not exceed 15 percent of your monthly income after taxes; however, this method does not take your other revolving debts into consideration.
Certain situations may require you to use a larger or smaller percentage of your income for car expenses. For example, if you have an extremely low income, you may have no choice but to devote more of your income to your car, especially if you must have a car for transportation. Conversely, if you have high debt or must devote a large amount of your income to other bills, such as utilities, it may be wise to lower the percentage of income you spend on your vehicle.
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