Before you rush out of the parking lot and into the financing office to sign the papers on that sweet ride, have you made a budget for how much you can spend on monthly payments? Better hold your horses and take a few minutes to determine the appropriate amount of income YOU should set aside to owning a used car, truck, or SUV.
Canadians are carrying a lot of debt. How much? According to TransUnion, a credit monitoring agency, the average Canadian owes $27,368 in consumer debt on things like lines of credit, credit cards, and of course, vehicle loans.
Now, debt isn’t inherently bad. It’s essential for investing in future wealth and opportunity (education, real estate, starting a business) or merely for convenience (purchasing a big ticket item when you don’t have all the cash upfront).
How about a used car loan? Is that a good or bad debt? “Neither,” says Jason Heath, a certified financial planner. Since most people don’t have all the cash up front to buy a vehicle and personal transportation is a necessary expense for most Canadians, getting a loan on a pre-owned car isn’t unwise.
You do, however, need to shop within your means.
How expensive is it to own a vehicle?
For first-time car buyers, this section will be of particular use.
Aside from the initial purchase price, what else do you need to account for when you want to buy a used car? Here’s a list:
Costs of owning and operating a car
- Registration and licensing fees
- GST and sales tax
- Financing costs
- Maintenance and replacement parts
- Parking/garage space
- Tolls and tickets
Rather daunting, isn’t it? Fortunately, most of these costs are spread over the lifetime of the vehicle and can be anticipated. For instance, you can calculate how much you can expect to spend on gas, get a quote for car insurance, and estimate other owner’s fees like bi-annual oil changes and tire replacement.
Use the 10+5 rule
So what percentage of your income can you comfortably spend on a used vehicle?
Most financial advisors recommend that you don’t spend more than 10% of your net monthly income (after taxes, deductions) on car payments. And a good rule of thumb is to allot 5% of your monthly paycheque towards the operating cost of a vehicle (see the list above).
That adds up to 15% spent on transportation related expenses.
Still having some trouble wrapping your head around these numbers? Here are some example situations:
For as long as she can remember, Kate has been a car enthusiast. Likely due to her father’s influence—who owns a 1965 Ford Mustang—Kate got her license as soon as she turned 16, has learned how to do basic repairs, and likes to attend vintage car meet ups in the summer.
A few months ago, Kate landed a new nursing job in Regina. She now takes home $3,100/month after deductions and is excited to replace her old car with a pre-owned Mustang GT. She has been saving up for a few years and will have a considerable down payment.
Using the 10+5 rule, Kate shouldn’t spend much more than $310/month on payments for a Mustang, and ought to set aside $155/month for operating expenses like gas, insurance, and perhaps the occasional speeding ticket.
Josh is a carpenter by trade and manages his own contracting company. He and the crew specialize in renovating older homes built in Winnipeg’s early 20th century. With a young son and a second child on the way, Josh and his wife, Brittany, are looking to upgrade to a larger crossover SUV. After researching online, they liked the favourable reviews and solid reliability ratings that the Ford Explorer has been receiving.
Together, Josh and Brittany earn 4,300/month. Following the 10+5 guideline, they should budget around $420/month for auto payments and $210 for owner and operating costs.
A note on down payments
You’ve likely heard car dealerships advertise the latest sale featuring something like “zero down payments and zero due at delivery on all remaining models.”
Being able to drive home in a new car without having to put any significant cash down beforehand sounds tempting, but it might not make for a very sound purchase in the long run.
From a lender’s perspective, a down payment is a type of promise that you have the income to comfortably pay off a used car loan over the course of your borrowing term.
Consequently, choosing to put zero money down on a pre-owned car means that:
- Your monthly payments will be more expensive.
- You run the risk of going “upside down” in your payments (a dealer term for owing more money on your loan than the car is worth).
Since all vehicles, even used ones, depreciate in value over the years, #2 is a major concern when you don’t supply a significant down payment, have a high interest rate, or your loan is for a particularly long term.
Therefore, most dealerships and banks require that you give a 10% down payment when you buy. Similarly to what a mortgage advisor will tell you about buying a home, we recommend putting as much cash down as you can when buying a pre-owned car.
Consider your lifestyle
Do you need to follow the 10+5 rule to the letter when buying a used car? No, everyone’s budget will be different.
If you’re like Kate and get a lot of enjoyment from owning a powerful sports car, you can probably stand to spend a bit more than 15% on your transportation costs because that Mustang also falls under Recreation. However, if you’re similar to Josh and have other expenses like daycare and diapers to pay for, it wouldn’t be a bad idea to consider spending a little less than 15%.
What matters most is understanding your finances and lifestyle before going shopping.
Credit: Driving Change Automotive Group – dcag.ca