No matter where you live in Canada, having a vehicle makes commuting a lot easier. While Canadian terrain is beautiful, it isn’t always the kindest on our vehicles (and wallets). If you find yourself starting the search for a newer vehicle, you should ask yourself this really important question: how much car can I afford?
We’ll break down the major considerations you should have when buying a new vehicle, from recommended car payments based on salary all the way to budgeting for extra maintenance. You’ll have a better idea of all the aspects you need to consider before purchasing a new vehicle you can realistically afford.
First things first: what is “affordability”?
We’d all love to have a vehicle with all the bells, whistles and luxurious features but it doesn’t always agree with our wallets. The most important thing when buying a new car is being able to afford your monthly payments, though there are ways you can have both!
Many people think of affordability in one of two ways when it comes to car-buying.
Scenario 1: I should purchase a new vehicle so I won’t have to worry about maintenance and other problems for a while.
Scenario 2: I should purchase a used vehicle to save more money upfront.
While these are valuable considerations, affordability unfortunately can’t be narrowed down into two simple options. Regardless of whether you buy new or used, you’ll have to budget for maintenance, insurance and other costs and ensure they all fit into your monthly income. You can use our car affordability calculator for Canadians to help you budget for vehicle costs.
When it comes to what you can afford, here are some factors that will affect the cost of your vehicle and its impact on your budget:
- Your credit score. Is it poor or very high? The higher your credit score, the better interest rate you’ll be offered and the more money you can save.
- How much you have saved for a down payment. The more you can pay upfront, the less your monthly payments will be, or, the shorter your loan term.
- Your loan term. Typically the faster you pay off your loan, the larger your monthly payments will be. There’s no “right” way to do it – you decide what timeline works best for you.
- The sales tax in your province. In Manitoba, it’s 8% but it changes from province to province. Sales tax will affect how much you can afford.
- The interest rate you qualify for. The lower your interest rate, the less you’ll spend and ideally, the more car you can afford.
The 20/4/10 rule
Ratehub, a Canadian financial comparison platform, is one of the many finance experts that outline and follow the 20/4/10 rule. Let’s look at the breakdown and how you can use this framework to determine how much car you can afford.
Your down payment should be around 20% of the purchase price
The reason experts recommend putting at least 20% down is because your car depreciates the moment you drive it off the lot. According to CARFAX, your car’s value will depreciate by at least 10% within the first month of driving and at least 20% in the first year.
If you put less than 20% down and have a long loan term, you could end up paying more than the car is worth given the rate of depreciation. However, if you can put more money upfront, your car payments will be lower and you’ll be closer to paying off your car.
Pay off your loan in 4 years or less
You pay interest on each car payment you make, so the longer your loan term, the more interest you’ll pay. The faster you can pay off your loan, the less interest you’ll pay. 4 years is a good benchmark to budget for.
Another thing to consider is some lenders may require you to pay a higher insurance premium while you’re paying your vehicle off (as a means of protecting what they’re lending). You’d likely have a higher monthly charge and it would be an added cost to budget for. This varies by lender so it’s always a good idea to ask.
Your monthly payments should be less than 10-15% of your net pay
To get the best car you can realistically afford given your salary, we recommend your monthly payment should be less than 10-15% of your earnings after taxes (your net, or take-home, pay). If you don’t know this number off hand, you can calculate it using neuvoo’s Canadian income tax calculator.
Let’s walk you through some examples.
Say you make $45,000 gross per year and you live in Manitoba. Your yearly net pay after tax deductions comes to roughly $33,843. This is your take-home pay.
15% of your total take-home pay comes to $5,076.45, which equals $423.04 per month. This means if you make $45,000 a year, you can spend around $423 per month on car payments. Keep in mind, this doesn’t include a down payment and if you had one, that number would change. That 15% also doesn’t include car insurance, gas or routine maintenance. This is where the 20% rule comes into play.
The 20% rule
While the 20/4/10 rule is reliable, many financial experts suggest your car payment and all other automotive expenses should not exceed 20% of your take-home pay. This 20% includes your car payment, gas, oil changes, insurance, maintenance and unexpected repairs.
If we go by this rule, this is approximately how much you would spend per month if 20% of your take-home pay went towards your total car expenses:
|20% of Take-Home Pay||Monthly Payment|
*Values calculated using neuvoo’s Canadian income tax calculator in Canadian dollars.
Keep in mind that this calculation is simplified, and doesn’t take into account your down payment, trade-in value or the duration of your car loan.
Birchwood Credit’s Car Loan Calculator and how it works
If you’d like a better estimate of your car payments, you can try our online Car Loan Calculator. This tool will help you estimate your bi-weekly or weekly payments based on vehicle cost, loan duration and your credit score.
When it comes to car loans, three important numbers are taken into consideration:
- The principal, or the total cost of the vehicle including taxes, loan administration fees and add-ons/special features.
- The loan term, or the length of time payments will be made on your loan. Terms typically range from 36 to 72 months.
- The interest rate, which is the percentage the lender charges you to borrow money.
These three numbers are represented in our Car Loan Calculator to give you estimated payments so you can budget for the car you want (and can afford).
Budgeting for additional car expenses
Once you approximate how much car you can afford based on your salary, it’s important to sit down and list the other costs that come with owning a vehicle. If you can budget your vehicle costs along with your other costs of living (rent, groceries, savings, etc), it’ll help you plan a well-rounded budget and give you a full picture of what is realistic for your lifestyle.
Here are some additional costs to keep in mind as you create your budget:
- Fees and add-ons. Oftentimes the vehicle that’s advertised is the base model with basic features. If you want a custom paint job or specialty features, you’re probably looking at a price increase. Make sure you clarify if the vehicle you want is the base model.
- Dealer-installed options. Some vehicles already have specialty features pre-installed, like command start, expensive tires or an alarm system. You can always ask the dealer if there are any installs that can be removed so the price is lowered.
- Additional warranties. Some finance managers at other dealers may try to sell you extended warranties or add-on features, which will bump up the price. If you purchase a vehicle with us, that won’t happen. We’re committed to transparency and sharing how certain options can benefit you, without any obligation to upgrade.
- Gas. This cost is a given but it’s often overlooked. Don’t forget to incorporate gas costs into your budget. Do your best to estimate how often you travel a month and how often you have to fill your tank. If you have to commute often, this is an expense you’ll have to account for.
- Regular maintenance. Every so often our cars need a tune-up, whether it’s an oil change, tire rotation or regular washes. Allocate some of your budget to these types of expenses and you’ll never have to worry when they come up.
- Repairs/emergency savings. If you’re able, it’s a great idea to put some money away for emergency repairs. Even if it’s a small amount per month, over time your savings will add up and you’ll feel good knowing you’re covered for the unexpected.
At Birchwood Credit, we help all credit types and we look at your entire financial situation, not just your credit score. Our in-house auto financing helps Manitobans get into reliable vehicles they love at fair rates.
Our offices have reopened, though if you’d prefer to shop from the comfort of your home, you can with our Buy From Home program. Your entire buying experience will be 100% contactless from the loan approval and vehicle shopping to the test drive and delivery. You’ll even get a $1000 rebate and other added benefits. Visit our Buy From Home page for details.