How do you determine what you should spend on a car? Many folks consider the monthly payments as the major determining value to use when buying a car. This is an important consideration since having money available is important. Equally, if not more important is the value of the car in relationship to one’s current income and lifestyle.
I believe a great rule of thumb to start with is the following formula– 10% of annual household income divided by number cars in household times the number of years you expect to keep the car. For example, a couple earning $100,000 a year with a two car family that plans to keep a car for 5 years should spend $25,000. That is 10% of $100, 000 ($10,000) divided by 2 cars times 5 years equals $25,000. This is just a rule of thumb so adjustments may need to be factored such as trade in value and cash available. Cars, in general, are more reliable than 10 or 15 years ago and as such can provide trusted transportation for longer period of time. Though I personally like keeping cars until they are ten years old this doesn’t work for everyone and I generally recommend holding a car for at least five years. I am not a fan of auto financing as car values (especially for new ones) drop greatly the first year. There are situations in which a particular type of vehicle is needed for one’s profession such as for a real estate agent where image can be important and financing may be appropriate.
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