Car loans 101: what car can you afford?

Looking to buy a new car this year? The excitement of car shopping often overshadows the most crucial question: what can you actually afford? 

Whether you're planning to buy outright or exploring vehicle financing options, understanding your true car buying budget isn't as straightforward as it might seem.

Let's walk through the process.

For a thorough financial review, you need to first gather 2-3 months of bank and credit card statements. This might seem tedious, but it's an important step for understanding your real spending patterns. From your daily coffee runs to monthly subscriptions, every expense adds up.

Here's where the magic happens: start identifying areas where you can make painless adjustments to boost your car buying power. Consider these practical money-saving switches:

• Bringing lunch to work three times a week 
• Cutting unnecessary subscription services 
• Finding cheaper alternatives for regular services like grooming, house cleaning or entertainment. 

These small changes could add an extra bit of cash to your monthly car budget. It might take a while, but $100-$200 saved per week can go a long way. To make this process easier, check out our budget calculator to crunch the numbers accurately.

When calculating car loan affordability, buyers usually focus on monthly payments. However, the true cost of owning a vehicle extends far beyond your repayments. Maintenance and operating costs can add to your vehicle expenses, but you’ll also have to pay fees, stamp duty, and insurance too.

Keeping these additional costs in mind is important for building a realistic car buying budget. Let's break down the often-overlooked expenses that can impact your total cost of ownership:

Regular maintenance and servicing

Modern vehicles require regular maintenance to maintain performance and reliability, including:

• Regular oil changes 
• Tire rotations and replacements
• Brake service 
• Scheduled maintenance. 

Essential onroad costs

These unavoidable expenses vary by location but typically include:

• Registration fees (varies by state and car type, paid annually)
• Stamp duty (depends on state, vehicle value and type)
• Compulsory third party (CTP) insurance
• Luxury car tax (if applicable).

Securing a favourable car loan is just the beginning – managing it effectively can save you thousands over the loan term. Based on some fairly common financial advice, your monthly car payment should be about 15% of your take-home pay. This leaves room for insurance, maintenance, and other vehicle-related expenses.

Let's explore proven strategies for optimising your car loan:

1. Only borrow what you need. There's a big difference between the interest you might pay on a $10,000 car loan and what you'll pay for a $50,000 loan. So decide what price tag your budget can realistically handle and use that to work out how much to borrow, instead of the other way around.
2. Extra cash. Work bonus? Tax refund? That could go towards your car loan. A chunky amount will make all the difference to what you owe in the long run, shaving months off your loan and interest which equals dollars in your pocket.
3. Round-up your repayment amount. By rounding up your repayment by $20 - $50 each month could shave many months to a year. Think of the interest you’ll be saving. 
4. Pay regular increments. This may depend on how frequently you’re paid, whether that be weekly, fortnightly, or monthly. Arrange to repay your car loan when you get paid from work. 

Remember: Every extra dollar you pay toward the principal reduces the interest you'll pay over the life of the loan.

Now that you have a bigger picture of your car buying budget, it's time to put this knowledge into action. Use this simple formula to calculate your maximum car budget.

Your budget

Monthly take-home pay × 15% = Monthly car payment 

For example, if you take home $4,000 monthly, your payment = $600 (15% of $4,000)

On a 5-year loan term (60 months), your budget comes to ($600 x 60) = $36,000 

Your loan

Okay, so let’s say you take out a loan of $30,000 at a rate of 10.35% p.a. over 5 years: 

Your repayments would be $643 per month, as per the Mozo Personal Loan calculator. 

Total interest over the course of the loan amount = $8,555.

From this quick maths, we know that your loan total over 5 years would be $38,555 ($30,000 loan + interest of $8,555).

Conclusion

We know that your budget based on your pay is equal to $36,000. So in this example, your budget would fall just short of your loan total ($38,555).

Because you would need to factor in monthly insurance, maintenance costs and any fees too, the sensible thing to do would be to take on a slightly smaller loan to fit with your budget, or to buy a smaller, less expensive car. 

In short, this above calculation at least gives you a starting point. 

Ready to start your car loan? Check out our car loan hub page and compare a bunch of providers today.