When it comes to purchasing a new set of wheels, used cars make the most financial sense. Since they are less expensive and don’t lose their value as quickly as a new car, they are the smartest choice for your long-term financial health. But how much should you spend on a used car?
As a good rule of thumb, you should spend no more than 20% of your annual take-home pay on a used car. For example, if you make $50,000 per year (after taxes), then you should plan to spend $10,000 or less on a used car.
Additionally, as we always recommend, you should save up enough money to pay cash for your car.
Since financing a car requires you to pay interest and limits your cash flow for the life of the loan, it is always best to purchase a vehicle outright.
In this article, we’re going to cover the basics of calculating how much you can afford to spend on a used car and how to get the most value for your money.
Understand How Much You Can Afford
The first thing you should do is calculate how much you can afford to spend on a used car.
A lot of people skip this step and head straight to the car lot to check out the inventory.
Unfortunately, this can create a situation where you find the perfect car and make an impulse purchase despite the vehicle being out of your price range.
By figuring out your budget first, you can ensure that you are only checking out cars that you can afford.
As I previously mentioned, our recommendation is that you spend no more than 20% of your annual take-home pay on a used car.
The easiest way to calculate this number is to multiply your monthly net income (i.e. your income after taxes) by 12 to get your annual take-home pay. Then, multiply that number by 0.2 (i.e. 20%) to get your max budget for a used car.
From there, all you have to do is save up and pay cash!
Picking The Right Car
Once you have established how much you want to spend on a car, you need to figure out what car will fit your budget.
Since there are tons of different makes and models on the market, selecting the right one can be a difficult task.
For that reason, there are several key factors that you should consider when choosing what type of car you need.
- Size or Type of Vehicle – First, narrow your search down to the type of car that you will use the most. If you have a family of five, you can safely eliminate the two-seater sports car. At the same time, you probably don’t need to purchase a seven-passenger minivan.
- Insurance Costs – Before you purchase any car, you should research the cost of car insurance. This is a fairly easy process, as most insurance providers include a free quote tool on their website, like this one from Liberty Mutual.
- Maintenance Costs – Some vehicles are notorious for having mechanical problems. The last thing you want is to get a good deal on a vehicle and end up spending a ton of money keeping it running. You can find a lot of information online about specific manufacturers or models. The goal is to find a vehicle that is reliable, but also inexpensive to repair if something goes wrong.
- Consider Fuel Economy – The purchase price isn’t the only expense that comes with owning a vehicle. If you put a lot of miles on your vehicles each year, you will want to know how many miles per gallon your selected model is expected to get.
Decide Where To Buy
You have two main options when looking for a used car — dealerships and private sellers.
While there are pros and cons to each of these options, the key is to make sure that you shop around.
This will help you find the best deals.
Car dealerships will likely have higher prices, however, they will have a much wider selection.
Additionally, their vehicles typically undergo a thorough inspection process and have been detailed before being placed on the lot.
Purchasing from a car dealership is also a little easier since they help you with the necessary paperwork to transfer the title.
On the other hand, with private sellers, you can usually get a better price.
This is because, in general, they are more motivated to sell.
Private sellers are a great source of information and likely have the full history of the vehicle including maintenance details and parts that have been replaced.
You will be fully responsible for handling the title transfer process, but this is fairly easy in most states.
Want more money-saving tips and tricks? Check out some of our other posts:
- 10 Best Ways To Lower Your Car Insurance Costs
- 7 Best Ways To Save Money On Car Expenses
- Do Car Dealerships Accept Cash? (Getting The Best Deal)
- 7 Ways To Get Better At Saving Money
- Buying A High-Mileage Car: 10 Practical Tips
- Should I Sell My Car To Pay Off Debt?
- Fix Hail Damage Or Keep The Money? (A Guide For Car Owners)
Only Buy What You Need
Just because you have a budget of $20,000 for a used car does not mean that you need to spend the entire amount.
You might find a great vehicle for $15,000.
Don’t eliminate cars just because they are significantly under your budget.
You can always use the savings to tackle another financial goal such as boosting your savings or adding to your Roth IRA.
You could also set that money aside to cover upkeep and maintenance or insurance premiums.
Evaluate The Vehicle Properly
Once you find the vehicle you want, you need to make sure that there are no underlying issues or problems.
After all, buying a used car that turns out to be a lemon could cost you thousands of dollars.
These issues are not always easy to spot, so you need to look carefully.
- Test drive – Never purchase a used car without taking it for a test drive. When you take the vehicle out, listen for any noises, vibrations, or other indicators of a mechanical problem. You also want to check all lights and other mechanical parts to ensure they are all working properly including the stereo, power windows, sunroof, power seats, and air conditioner.
- Pay a mechanic to inspect the car – Unless you know a lot about cars, you might consider hiring a licensed mechanic to inspect the vehicle. A mechanic will typically charge $100 to $200 for a comprehensive inspection, however, this is a lot cheaper than paying thousands for repairs later. A mechanic can also give you some insight into how easy the model is to repair. Remember, cars that are difficult to work on usually cost more to maintain.
- Request a vehicle history report – A vehicle history report will tell you information about past owners, accidents, odometer readings, and open recalls. Most dealers will provide this to you for free. If the dealer won’t provide one or you are purchasing from a private seller, you can request one yourself for about $25. All you need is the VIN number (vehicle identification number).
Compare Pricing Online
You also need to make sure that the price listed for the car is reasonable and fair.
Fortunately, there are lots of resources online to validate whether or not you are getting a good deal.
Kelly Blue Book has been the gold standard for decades for looking up the value of used cars.
Another resource is the online marketplace, Autotrader.
The great thing about these two options is that they both have a mobile app.
This makes it easy to quickly look up the appropriate sale price for the vehicle right from the car lot.
Negotiate The Sale Price
Whether you are buying from a dealer or private seller, you should be ready to negotiate.
The seller almost always adds a little to the list price with the understanding that most buyers will offer less.
To negotiate the price successfully, be cordial. People often try to come in with a firm hand which makes the seller less likely to want to work with you.
You can start by asking the seller the lowest price they would accept for the vehicle.
In some cases, you can get them to immediately budge on the price (“well, I was hoping to get $15,000, but I could probably let it go for $12,000 – Bingo!).
This scenario is most likely with private sellers as the sales people at car dealerships are more experienced.
Another strategy is to offer a little lower than you would be willing to pay for the car based on your research. If you believe the car is worth $18,000, you might start by offering $16,000. This is called “anchoring”.
It’s the starting point for negotiation. If you end up paying $17,500, you still got the car for less than you estimated its value.
Get Freebies From The Dealer
In some cases, you can get more bang for your buck for asking the dealer to throw in additional items for free.
These extras can include window tinting, anti-theft devices, all-season floor mats, wheel locks, splash guards, or additional keys.
Some of these can be easily secured by simply asking during the negotiation process.
You can also get the dealer to throw in a few free oil changes, tire rotations, and car washes.
However, one add-on to be cautious of is extended warranties. In most cases, these will end up costing you a lot more than they will save you.
Don’t make an impulsive decision or be pressured by the people at the dealership. Warrantees are a huge profit center for dealerships, so they are incentivized to sell you one.
Set Up A Car Sinking Fund
Most people don’t have $10,000 or $15,000 laying around, so you will likely need to save up for the car.
One savings strategy is to set up a sinking fund.
A sinking fund is money that you set aside for a specific purpose, like paying for a vacation, buying a house, or in this case, buying a car.
To start your sinking fund, decide on the amount of money that you need to save and pick a target date. Then, divide the total amount by the number of months so you know how much money save each month. For example, if you plan to buy a $10,000 car in two years, you will need to save about $415 each month.
After you purchase the car, you can continue contributing a reduced amount to your sinking fund to cover upcoming expenses such as repairs, oil changes, or new tires.
If you’re in the market for a new set of wheels, we highly recommend buying a used car.
Not only will they cost less and depreciate at a slower rate, but they also provide you with the opportunity to negotiate and purchase from a private seller.
All that said, before you go throw down a bunch of money, it’s important that you figure out how much you should spend on a used car. And hopefully, this article has helped you nail down the perfect budget.
So, how much do you plan to spend on a used car? And what kind of car are you planning to buy? Be sure to drop your answers in the comments below.
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