How to Use an Auto Loan Calculator
When shopping for a vehicle, it’s important to know how much car you can afford. Luckily, there are many online calculators to help you figure that out. Before you use these calculators, you might want to consider the 20/4/10 rule for car buying. The goal of this rule (or principle) is to help consumers avoid spending too much of their income on a car payment. Simply stated, the 20/4/10 principle suggests that car buyers should:
- Make a 20% down payment,
- Finance for no more than 4 years (48 months), and
- Spend no more than 10% of take-home pay on a car payment.
With the 20/4/10 guidance in mind, here are the most common steps to follow when using auto loan calculators.
Step 1: Enter Your Desired Vehicle Price or Monthly Payment
If you want to calculate based on the vehicle price, do your research to determine the value of the car, and don’t go above that.
If you want to calculate based on monthly payment, remember that according to the 20/4/10 principle, you should spend no more than 10% of your monthly take-home income on a car payment.
- For someone who takes home $4,000 a month, their monthly car payment should be no more than $400.
- For someone who takes home $2,500 a month, their monthly car payment should be no more than $250, and so on.
So figure out what 10% of your monthly take-home pay is, and that is the most you should pay per month. As a result, you have to make sure the sales price of the vehicle does not take you over this amount.
Step 2: Choose a Financing Term
The 20/4/10 rule suggests a financing term of no more than four years (48 months). The truth is many buyers are currently choosing to finance for 60 months or even 72 months. They are doing this because the monthly payment for a 48-month term is too high. By extending the term to 60 or 72 months, they can afford the monthly payment, but they end up paying more in interest and a much higher overall sales price, which hurts their financial well-being.
Step 3: Enter an Annual Percentage Rate (APR)
You can enter an interest rate estimate based on your credit score. If you’re unsure what APR to enter, refer to this Experian article that explains what loan rate borrowers can qualify for based on their credit score.
Step 4: Enter a Trade-in Value
If you plan to trade in a vehicle, enter how much you think your car is worth. Be realistic and do some research first to see what cars of a similar age and condition are worth according to car appraisal sites.
Step 5: Pick a Down Payment
Enter the down payment amount you think you can afford. Remember, if you want to follow the 20/4/10 principle, your goal should be to put down 20% of the car’s sticker price. Note: the 20% can be a combination of a down payment AND a trade-in if you have one.
Step 6: Let the Calculator Go to Work…Then Play with the Numbers
Let’s say that before you began, you thought you could afford a $500 monthly payment. But, after running the numbers through the calculator, it appears you can only afford a $400 monthly payment while adhering to the 20/4/10 rule. So what now? Well, play with the numbers. Enter different amounts into the calculator to see how those changes affect the sticker price you can afford to pay.
Words of Advice
If at all possible, focus on the sales price of the vehicle, not the monthly payment. You don’t want to pay $24,000 for a vehicle that is only worth $20,000. That’s a $4,000 hit to your net worth! But that’s what could happen if you finance a car for too long, put too little money down or pay too high of an APR. Don’t be blinded by the monthly payment. Focus on the sales price and strive to not pay more than the car is worth.