When you decide that getting a loan for a new or used car is the right decision for you, the next step is deciding the size of the loan; this is no easy task. However there are some rules that can help guide you on choosing the appropriate size car loan for you.
- Maximum Allowable Loan: Generally speaking it is possible to take out a loan that totals more than six to ten times your monthly gross income, gross income referring to the amount you make before taxes. However, staying on the low end of this spectrum is generally best.
- Recommended Car Payment: In addition, most financial guru’s recommend not spending more than eight to ten percent of your gross monthly income on a monthly car payment. This essentially means that, at most, you can spend 1/10 of what you make a month on a monthly car payment.
- Loan Length: After you calculate a number that fits the two criteria mentioned above it is then important to choose a desirable length for your loan. Loans with a length of 72 months or more have become popular recently due to the relatively low monthly payments, but this is misleading. It is important to remember that the longer the length of the loan you choose the more you will end up paying in interest and thus overall for your car.
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While it is relatively simple to determine the ideal loan for yourself lenders might have something else in mind. A lender will take into consideration other factors before offering you loan terms. These factors include, but are not limited to, income after taxes, credit score, and current debt load. Not all lenders are the same when choosing determining factors but there are some constants.
You will need to have an after tax income of at least $1250 and cannot be in debt for more than 30% of your after tax income. Finally, your credit score will be taken into account and as you can imagine, the worse your score is the less you will likely be allowed to borrow.
As stated before it is best to borrow between six and ten percent of your gross monthly income. The determining factor for whether that number will be closer to six or ten happens to be credit score. If a borrower has very good credit he or she will be able to borrow 10X, conversely those with extremely bad credit will be limited to a number closer to 6X. The majority of people will fall somewhere between perfect credit and abhorrent credit and therefore will be granted a loan of somewhere between 7X and 9X their gross monthly income.
Lastly it is important to remember that a car loses value every month you own it. It would be unwise to spend a great deal of money on something that is essentially becoming less valuable every day. Also, the less you borrow the shorter you can make the loan period and the less you will pay in interest in the long run.