How much car can I afford is a question many car buyers Google before making their next vehicle purchase. In this video I teach you the most you can afford to pay for your next vehicle.
More car buyers than ever are trading in vehicles that are worth less than they owe on the loan. This means they’ve purchased a car they can’t afford, they’re under water, and they’re bringing negative equity with them to their next deal.
There’s one simple way to stop this from happening: Pay off your car faster than your car loses value.
In the figure below I’ve graphed the loan options for an average vehicle purchase of $35,000 and compared the remaining balance on those loans over time to the trade-in value of the used car. This figure assumes $0 down payment and sales tax has been excluded which can add several thousand dollars to the owed balance.
What you can see from the figure is car loans of 36 months or less keep up with depreciation from the start. A buyer with a 48 month loan must pay for 1-2 years before breaking even, and then out pacing depreciation. For a 60 month car loan the buyer must makes payments for 2-3 years before breaking even. This extends to 3-4 years for a 72 month loan and 5-6 years for an 84 month loan.
You however, might now be purchasing an average vehicle, which depreciates ~50% after 5 years. In the slide below I’ve included two (2) tables side by side to compare the fastest depreciating vehicles to the slowest depreciating vehicles.
Electric vehicles like the Nissan Leaf and Chevy Volt top the list of fastest depreciating vehicles because they are subsidized by the government. The new car price with subsidy does not translate efficiently to the secondary market. Luxury vehicles also top the list for fastest depreciating cars because buyers from that segment want the new version, not the 5 year old version, and this translates to a weaker secondary market.
On the other hand, vehicles that outperform the average and hold their value well include the Jeep Wrangler, pickup trucks like the Toyota Tacoma and Chevy Silverado. The lone car in the top 10 for slowest depreciating vehicles is the Subaru Impreza.
The first time I really understood the significance of the variety in model specific depreciation was after a couple came into the dealership where I worked. They were borderline heartbroken their Lincoln MKZ had depreciated 50% in 3 years. Until that point I had taken vehicle depreciation for granted. All cars do not lose value equally over time. Depreciating 40% instead of 50% over 3 years is a $3,500 savings on a $35,000 car. Spending $50,000 on a Jeep Wrangler Unlimited instead of a Mercedes E Class could save $10,000+ when comparing the depreciated values of each vehicle after 5 years.
The affordability rule of the past has been the 20/4/10 Rule which requires a car buyer to put 20% down payment, limit their loan to 4 years or less, and not commit more than 10% of their monthly income to the car payment. From my experience as a car salesperson I can say few modern buyers follow this advice.
Keeping pace with depreciation is the essential modern affordability criteria. But there are other implications to merely breaking even after 60, 72, or 84 months. In the figure below I’ve compared the interest paid on $35,000 loans ranging from 36-84 months:
The difference in interest paid between a 36 month loan and an 84 month loan of $35,000 at today’s typical car loan rate of 5% interest is over $3,500.
A buyer committed to paying for 5 years just to break even can technically afford the car despite the higher interest payments. But I think a fair question of self-reflection to be asked is: If a buyer can’t afford to pay off a car in 3-4 years, why can they afford to pay several thousand dollars more in interest than another person for the same vehicle? I don’t think there’s a right answer, I just know the car salesperson you work with next won’t be asking the question.