Rising car payments making standard affordability rules 'impossible'

As car prices and payments soar, it has become increasingly difficult to rely on many traditional rules of thumb used to determine how much you can afford in auto payments.

"We have so many people relying on rules of thumb and it's impossible to use them," Saijal Patel, the founder and chief executive of personal finance firm Saij Elle, told Yahoo Finance Canada in a phone interview.

"It's dangerous, in my mind, to use them because you have to put it all in context."

One long-standing rule of thumb that has permeated the personal finance world is that your total vehicle expenses, including the payment, gas and insurance, should equal 10 to 15 per cent of your gross pay.

Another common affordability rule when buying a vehicle is the 20/4/10 method. It suggests having a downpayment of at least 20 per cent, the car loan should be no longer than four years, and the monthly payment shouldn't be more than 10 per cent of your take-home pay.

But Patel says the reality of purchase prices and ownership costs often exceed those rules, so a broader look at a person's financial situation is needed to determine affordability.

"I would never advise someone about a car without understanding their entire income, expense picture and all the other goals and necessities first," she said.

"My point is rule of thumbs – 9/10 don't work. Because every circumstance is different and when you have limited resources competing with many priorities, you have to plan and then prioritize."

Personal finance comparison website Finder.com says Canadians typically spend between $400 and $800 on the average car payment. For new vehicles in particular, the average monthly payment is closer to the higher end of the range. Factor in gas, insurance and maintenance/repair costs and that number balloons, easily exceeding traditional car affordability guidelines.

Patel provides the example of a $45,000-plus-tax vehicle purchase with a 20 per cent downpayment. A four-year loan at three per cent interest would cost $940 per month. Factoring in $500 for insurance, gas and maintenance, and the monthly cost of that vehicle would total $1,440.

For an individual with an annual salary of $72,000, or about $4,273 per month after tax, the vehicle would eat up 34 per cent of their monthly income.

"Those are real numbers. And then you have rent, you have food, and you have to save for retirement. So how can you make those ends meet?" Patel said.

She says she would advise clients to tally their monthly net income and fixed expenses to gauge how much money is left over to possibly contribute to a car.

How to save on car payments

Patel says purchasers can consider saving up a larger downpayment for the vehicle to bring down the monthly cost, or stretch the car loan beyond the four-year guideline, which "isn't the worst thing in the world," she says, especially if the car is a necessity.

When a dealership offers promotional financing, such as zero per cent financing or no payments for a number of months, Patel warns buyers to read the fine print.

Reading the fine print on dealer financing options can uncover unnecessary add-on features, extra fees, and provide a better understanding of the interest rate being charged.

"Dealers are getting creative when trying to attract new customers and one popular method is the 0% financing promotion. Generally, interest-free loans are not a good idea if you're constantly juggling bills, often late at making payments or can't find extra funds to pay down higher-interest debt," said Romana King, senior finance editor at Finder, via e-mail.

For those who consistently pay bills on time and can plan to pay back loans quickly, a financing promotion might be a decent option, she adds.

"Just be sure you've run the numbers and you're confident you can repay the loan, or a large portion of the loan, within the promotional period to avoid hefty interest charges (and keep monthly payments lower)," she said.

King also suggests sorting out financing prior to stepping on a car lot, rather than trying to negotiate with the dealer on both car price and financing terms.

Buyers can also seek out vehicle models that might have lost popularity with consumers.

"While inventory was tight over the last few years, there are always makes and models that fall out of favour. If you're not stuck on one or two makes/models, you can snap up these out-of-favour models at a cheaper price," she said.

Michelle Zadikian is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @m_zadikian.

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