What’s the Rule of Thumb for Car Buying — Is It 3x Your Income? Here’s What Experts Say
Buying a car is an enormous financial decision and can cause some sticker shock. Indeed, Kelley Blue Book noted that the average cost of new cars is now more than $47,000 — up a whopping $6,000 from two years ago and $10,000 from September 2020, according to Consumer Reports.
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What’s more, the average car payment for new vehicles was a record-high $738 per month in the fourth quarter of 2023, a 2.5% increase from the fourth quarter of 2022, according to LendingTree. The average car payment for leased vehicles increased at a comparable 2.4%, while the average car payment for used vehicles increased by just 0.4%.
Against that backdrop, it’s no wonder that consumers want to think twice when making such a big purchase and look for guidance as to how much they can afford.
“The cost of buying a car is one thing, but the costs of owning a car is a different ball game, and determining how much of a car you can afford also depends on multiple factors,” said Renée Horne, chief marketing and customer experience officer at Chase Auto, JPMorgan Chase.
As Horne explained, several ongoing costs of ownership determine how affordable a car may be in the long run, such as maintenance and repair, fuel, loans and interest, insurance and more.
“Being honest about your needs versus wants will help you make a practical decision about the type of car and type of loan that fits your lifestyle and financial goals,” she added.
Should You Use the ‘3x Your Income’ Rule?
As Fidelity explained, for many first-time buyers, a good budget guideline is to look for a home that is about three to five times your household annual income. But does this rule apply to consumers buying a car?
Cliff Ambrose, FRC, founder and wealth manager, Apex Wealth, argued that unlike home buying, where the three times income rule is a general guideline, car affordability is more nuanced.
“While some may suggest a similar rule for car buying, it’s essential to consider other factors such as existing debts, lifestyle, and financial goals,” he said. “Experts often emphasize the importance of a holistic approach, taking into account not just income but also expenses, savings goals, and the overall financial picture.”
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Use Your Payment-to-Income Ratio or Your Debt-to-Income Ratio
You can use your payment-to-income ratio (PTI) — which ideally should be 15% or lower — and which measures your car payment as a percentage of your income, Horne said. To calculate your PTI, you divide your monthly car payment by your monthly gross income.
“When considering how much of an auto loan one qualifies for based on their salary, your salary plays a significant role in determining the amount lenders are willing to offer you,” she said. “Generally, lenders assess your debt-to-income ratio (DTI) to determine your eligibility for an auto loan. To find your DTI, divide your monthly debt payments by your monthly income.”
As a rule of thumb, she added, the lower your DTI, the greater the car payments you should be able to afford relative to your income. That said, a great place to be is if you have a sub-35% debt-to-income ratio, she added.
And as Ambrose further pointed out, while lenders may approve loans up to a certain percentage of one’s income, experts caution against maxing out this limit.
“Instead, they recommend aiming for a monthly payment that comfortably fits within the budget without sacrificing other financial priorities like savings and emergency funds,” he said.
Finally, Horne added that in determining how much to spend on a car, understanding the true costs of the car but also how this car will fit into your existing expenses is crucial.
“Tracking income and expenses, categorizing spending into essential and non-essential, and analyzing your debt-to-income ratio all contribute to making an informed decision,” she said, adding that setting a budget beforehand helps in finding a vehicle that fits comfortably within your financial constraints.
The 20/4/10 Rule
This rule recommends making a downpayment of no more than 20% of the vehicle’s cost, not taking a loan with a longer term than four years, and not allowing the monthly payment to exceed 10% of gross monthly income, said Peter C. Earle, senior economist, American Institute for Economic Research.
Yet, he also noted that this rule would’ve been exceptionally difficult to follow over the past few years, given the toll inflation has taken on car prices.
“From June 2020 to July 2022, the CPI [Consumer Price Index] for used cars and trucks (not seasonally adjusted) rose 56% while from April 2021 to June 2023 the same index for new cars and trucks rose 21%,” he said. “Used cars and trucks prices are still, as of February 2024, up 36% from the summer of 2020. New vehicles, similarly, are still up about 19% since April of 2021.”
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