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Buying a car should be exciting. But nowadays you can’t ignore the financial burden — or the risk of overextending yourself.

The average price of a new car reached a new record high of over $50,300 last month, a good $10,000 above what it was in 2020, according to Kelly Blue Book estimates. Used cars average more than $26,000, and some of the most affordable ones are the hardest to find.

The real shock, though, is what these stats mean for car payments. By the end of last year, financing a new car cost an average of $772 a month, and 1 in 5 buyers were paying at least $1,000, according to Edmunds, an online car shopping guide. Even used car payments averaged a hefty $570.

The pressure is clearly mounting, too. In order to make the math work, more buyers are stretching loans out over six or seven years — sometimes paying thousands more in interest. Federal Reserve data shows the rate of auto loan delinquencies has risen sharply since the pandemic and is now at its highest level since 2010.

So what?

For many of us, a car is one of the biggest purchases we’ll make, and auto loans make up nearly a third of all non-mortgage household debt in the U.S. If you’re in the market for a car, take the time to run the numbers so you know what you can afford before you start shopping.

Here are three ways to gauge what your budget should be:

•  The % of income method: Probably the simplest approach is to keep your payment under a certain percentage of your net monthly take-home pay. Edmunds recommends staying below 15% if you’re buying a new car and 10% if you’re buying a used one (because repairs and maintenance costs add up.)

  So if you bring home $4,000 per month, your payment shouldn’t be more than $600 if you’re buying a new car and $400 if you’re buying a used one.

  (Of course, you’ll want to consider the cost of auto insurance, too. Edmunds says ideally you don’t want to go above 20% of your take-home to cover all car costs.)

•  The debt analysis method: This approach relies on your debt-to-income (DTI) ratio, taking into account not just your income, but your other debts, too. Your DTI is how much of your monthly gross income is used for debts (car loans, student loans, mortgages, credit cards, etc.) and lenders say ideally you shouldn’t go over 36%.

  So if your gross income is $12,000 a month, and your current debts total $3,500, a DTI of 36% means you could afford a car payment of up to $800. (Because 36% of $12,000 = $4,300 and $4,300 - $3,500 = $800.)

  Pro tip: Work backwards to figure out how much car payment you can afford. Take 36% of your gross monthly income (or check your DTI in SoFi’s free debt tracker) and then subtract your total monthly debt obligations from that number.

•  The down payment method: The “20/4/10 rule,” as it’s known, also takes into account your down payment and the length of your loan. This general rule of thumb recommends putting 20% down, taking out a loan of no more than four years, and keeping your payment and other car costs to 10% of your monthly income.

  So if you want to buy a $30,000 car, you’d put down $6,000, borrow the other $24,000 over four years, and make sure your car bills didn’t exceed the 10% threshold. (For a benchmark, a $24,000 4-year loan charging 10% interest would cost just over $600 a month.)

Keep in mind that a lot will also depend on the terms of your auto loan, especially the interest rate and how long you have to repay it. You may not have a ton of flexibility with the interest rate (though new cars generally have lower rates,) but you can lower your payment by borrowing for longer. Just remember that you’ll pay a lot more interest over the life of the loan, and if you need to sell before it’s paid off, you could end up owing more than your car is worth.

(To better understand how these levers could play into your payment, try running different scenarios through an auto loan calculator like this one.)

The bottom line: These methods are just meant to guide, and your payment sweet spot may differ. The important thing is to have a clear strategy that you’re comfortable with before you hit the car lot. That starts with understanding how your income, debt obligations, and loan terms factor into your payment.

Related Reading

Americans Are Paying More Than Ever for Cars. Cheap Models Are Disappearing (CNN)

6 Ways to Cut the Cost of Your Car Loan (Investopedia)

$1,000 Car Payments Usher in an Era of Longer Auto Loans (SoFi)

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