How much can I afford?
Many people overspend on vehicles. Especially in today’s world where vehicles become more and more expensive. There is a guideline for purchasing new vehicles that I truly believe in. To give credit where credit is due “The Money Guys” developed this guideline. This rule is known as the 20/3/8 rule.
20/3/8 Rule
Let’s break it down.
The 20 stands for 20% down at minimum. That means when you buy your car you need to put 20% down on the sale. If you buy a car for $24,000 you need to put $4,800.
The 3 stands for 3 year or 36 month contract maximum.
The 8 stands for no more than 8% of your gross income in payments each year. If you make $36,000 you should not pay more than $240 dollars a month. The way to figure this out for your gross income is (Gross Income x 0.08 = Yearly Payment Not to Exceed, Then you take Yearly Payment Not to Exceed / 12 = Monthly Payment.)
One last thing 20/3/8 is not for each vehicle you buy. This is for all your vehicles so all your payments combined should not exceed 8% of your gross income.
Why follow the 20/3/8 Rule
The benefits of following the 20/3/8 rule are listed.
The 20% makes sure your car value doesn’t go below what you owe on the vehicle when you drive it off the lot. This may not be the case every time. If you find the vehicle value goes below what you owe on it when you drive it off the lot it probably means your overpaying for the vehicle.
The 3 helps ensure your car is valued more than the amount left on the vehicle through the length of the loan. This will help keep you from going upside down on the vehicle while you pay on it.
The 8% ensures you are not buying a vehicle out of your price range and stressing your finances.
This means if life throws you a curve and you need to sell your car you don’t sell it at a loss. If you do have to sell it a loss it will be very minimum. This rule does not guarantee you will not be upside down in your vehicle, but it will help limit it.
I Want a Nicer Car
I get it! I would love to have my dream car. Let’s be honest if you are reading this article you’re trying to get your finances in order. Based on where you are financially this rule can be modified. Let’s say Jim wants to buy a $45,000 truck. Jim makes $60,000 dollars a year. How does Jim afford this truck? There is really only one way to do this and that’s to increase your down payment. Based on Jim’s salary we know that Jim can only afford $400 a month. This means Jim needs to put enough down to get the payments to $400. Jim would need to put $30,600 down, which is 68% of the vehicle price.
Yes Jim can buy his dream truck but it will take a considerable amount more down. When should Jim buy his dream truck? There are a lot of variables that play into this. The one thing I would say is Jim needs to have no debt excluding mortgage. If wanting to buy your dream car is your goal, ensure all your other finances are in order. Increasing your loan term in order to lower your monthly payment for a vehicle is not financially smart.
Buying Used
I really want a new car! The intent of a car is to get you from point a to point b. So do you really need the fancy new car? NO! Do I need a reliable car? Yes! If your goal is to reach financial freedom than your dream car can wait.
Do your research when buying a used car. That includes if you buy it from a dealership or from an private seller. Do your research!
What is research?
Find out how much the car is worth. This avoids you overpaying for it.
Look into the reliability of the vehicle. Search Google for issues common to the vehicle.
Take the vehicle to a trusted mechanic and ensure they looks over it. Yes this will cost some money upfront but will save you money in the long run. YES, still take the vehicle to a mechanic if buying it from a dealership.
Conclusion
We would all love to buy our dream car. While trying to reach financial freedom this may not be possible. However, we can afford a reliable car. Based on your finances, figure out what you can afford and buy a vehicle in your price range. If you follow the 20/3/8 rule you will find you have a paid for car that you can keep driving and eliminate your car payment all together. Allowing you to pay off other debts faster or invest, and one day purchase your dream car.
