If you’re looking for a car buying rule, you’ve come to the right place. I’ve come up with a car buying rule that will help you spend responsibly, reduce your car ownership stress, and boost your net worth over time.
In 2009, I watched in horror as a total of 690,000 new vehicles averaging $24,000 each were sold under the Cash For Clunkers program.
The government’s $4,000 rebate for trading in your car ended up hurting hundred of thousands of people’s finances instead. With a median household income of only around $50,221 at the time, spending $24,000 on a new car was clearly too much.
Instead of buying a $24,000 car in 2009, if you had invested the $24,000 in the S&P 500, you would now have roughly $70,000 in 2020. That’s quite an opportunity cost for buying a new car!
Buying too much car is one of the easiest and biggest financial mistakes someone can make. Besides the purchase price of a car, you’ve got to also pay car insurance, maintenance, parking tickets, and traffic tickets.
When you add everything up, I’m pretty sure you’ll be shocked at how much it really costs to own a car and hurl.
The Car Buying Rule To Follow: The 1/10th Rule
The #1 car buying rule to follow is my 1/10th Rule For Car Buying. The rule states that you should spend no more than 1/10th your gross annual income on the purchase price of a car.
If you make the median per capita income of ~$42,000 a year, limit your vehicle purchase price to $4,200. If your family earns the median household income of $64,000 a year, then limit your car purchase price to $64,000. Absolutely do not go and spend $36,000, the absurdly high median car price today!
If you absolutely want to buy a car that costs $36,000, then shoot to make at least $360,000 a year in household income. You might scoff at the necessity to make such a high amount. However, it takes at least $300,000 a year to live a middle class lifestyle with a family in a big city today.
If you actually want to save for college, save for retirement, take care of your parents, buy a home, and not stress out about money when you’re old, please keep your car purchase to at most 10% of your annual gross income.
Once you buy a car following my 1/10th rule, your goal should be to own your car for at least five years, if not 10+ years. Don’t go selling your car every 2-3 years like most Americans do. If you do, you don’t experience the full value of the car. Further, you end up paying wasteful sales taxes each time you buy a new or new used car.
Buying a car you cannot afford is the #1 way to financial mediocrity. Since Financial Samurai was founded in 2009, my goal is to help readers achieve financial freedom sooner, rather than later. Ideally, I’d like every reader to achieve an above average net worth for their age.
Financial independence is worth it. A car you cannot comfortably afford is a great headwind.
Why You Shouldn’t Spend More Than 10% Gross On A Car
Let’s go through specific reasons why you should follow my car buying rule.
1) Maintenance costs: The more you drive, the more you will pay to maintain your vehicle. With thousands of parts per car, something will inevitably break or need upgrading. Not only do you have to pay for maintenance costs, you’ve also got to pay for insurance, parking tickets, and traffic tickets. Furthermore, the thrill of owning a new or new used car lasts for only several months, but the pain of paying the same car payment lasts for years.
2) Opportunity cost. When you buy a car you lose the opportunity of investing your money in assets that will likely grow and pay you dividends in the future. Everybody knows to save early and often to allow for the effects of compounding. Buying too much car is like negative compounding! Imagine how much money you would have accumulated if you invested $300-$500 a month in the stock market since 2009 instead of paying for a car?
3) Stress. When you pay more than 1/10th your income for a car, you will become more stressed. You’ll feel stressed whenever you get a door ding after parking your car at the local grocery store. You’ll get stressed whenever you incur wheel rash after parallel parking too close to the curb. Sometimes when you’re driving in traffic, you’ll feel more on edge because you don’t want anybody damaging your car. If you are within 1/10th of your income, you drive and park stress free. You stop caring about door dings, bumper scrapes, even break ins. Stress kills folks.
4) Makes you want more. The nicer your car, the more you want to spend on other things. You start thinking stupid thoughts like: I’ve got to buy a matching chronometer watch, driving shoes, and outfit. You start paying $20 for valet because you want people to see you come out of your car instead of park for free.
5) Makes you feel stupid. Deep down, you know that if you can’t pay cash for your car, you can’t afford the car. Each payment you make is a reminder how foolish you are with your money. Why would you want to be reminded every single month of being dumb? The thrill of owning a nice car fades after about six months. But the payment stays the same for years.
If You’ve Already Bought Too Much Car
Look, everybody makes dumb financial moves all the time. The important thing is to recognize your mistake, stop, and fix it! Here are some things you can do if you’ve bought too much car already.
1) Own your car until it becomes worth 10% of your income or less. This is the simplest solution if you’ve spent too much. Drive your car for as long as possible until the market value is worth less than 10% of your gross annual income.
2) Bite the bullet and sell your car. If you’ve spent anything more than 1/5th your gross annual income on a car, I’d sell it. It’s making you poor. Even if you have to take a little bit of a hit, I think it’s worth getting rid of your vehicle. Don’t trade it into the dealer because you’ll get railroaded. Instead, try negotiating via Craigslist.
3) Punish yourself. If you don’t punish yourself, then you will repeat your mistake and feel fine with what you have now. For the life of your car loan, take away a food you love to eat such as chocolate. If you are a coffee addict, swear never to drink that stuff again! Save more of your income after taxes and feel the squeeze so that you realize how ridiculous your car spending is.
Recommended Cars By Income (Tastes May Differ)
Cars built in the 1990s and beyond are so much more reliable than those built prior. If you are serious about improving your finances, consider buying a car with less options, and less electronics to deal with. The more you have loaded in your car, the more maintenance headaches you will have in the future.
The Choice For Great Wealth Is Yours
Treat the 1/10th rule of car buying like a game. You will be surprised to find how many different type of cars you can buy with 1/10th your income if you make over $25,000 a year.
If you want a $30,000 car, get motivated by the 1/10th rule to figure out a way to make $300,000 a year. One way is to start a side hustle to generate more income on the side.
I never thought when I started Financial Samurai in 2009 that I could leave the corporate world for good in 2012 and make more than I did as an Executive Director at an investment bank, but here I am.
If you can’t get motivated, then fine. Just don’t think you can afford much more. Think about your future and the future of your family. A car is simply there to take you reliably from point A to point B.
If you’re thinking about prestige and impressing others, don’t be silly. Owning a nice property is way more impressive because at least you can potentially make some money from the asset!
One of the worst financial combos is owning a car that you purchased for much more than 1/10th your gross income and renting. You now have two of your largest expenses sucking money away from you every single month.
Think about all the wealthy people you know or the millionaires next door. Chances are high the majority of them own their homes and drive used cars that don’t come close to 50% of their gross income.
If you want to achieve financial independence and not have to worry about material things stressing you out, follow my car buying rule.
If you want to detonate your finances and end up working longer than you want for the sake of a nicer ride, then go ahead and spend more than you can comfortably afford. After all, we’ve only got one life to live.
Recommendations
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Lower Your Auto Insurance Costs: Check out Esurance online for some of the best plans with the lowest rates around due to their lower overhead costs. It’s worth spending a moment filling out a quote to see if you can save some money. Car insurance is one of the largest ongoing expenses for car owners. Esurance has good driver discounts, and multi-product discounts as well. There is no obligation to sign up once you get a quote either. You want to leverage the internet to get the lowest rates.
Track Your Net Worth Religiously: Hopefully you are now motivated to make more money to afford the car of your dreams, instead of going into debt and buy a car you can’t comfortably afford. The easiest way to grow your wealth is to know where all your money is going.
Sign up for Personal Capital, the best free financial tool on the web. I’ve been using them for free since 2012 and have seen my income and net worth skyrocket. The app keeps me motivated to spend smartly and invest wisely. There is no rewind button in life. Best to get your financial life in order.
Updated for 2020 and beyond.
Being obsessed with material possessions is unhealthy, such as a car. On the flip side, being obsessed with building one’s net worth is also unhealthy.
In light of hyper consumerism and materialism, exhortations to be frugal, are certainly welcome, and people should listen to those voices, but people should also think critically about their own situations and apply the spirit behind the advices.
If you make $30k, spending $30k on a car is likely to be financially irresponsible. Buying a $3k used car that will likely expose you to higher risk of harm may also be irresponsible to your well being.
The ultimate goal in life isn’t to have the material possessions (or some ideal) of your dreams. It also isn’t to become financially independent by 40 either.
But who believes/cares about ultimate things anymore. Surely, only very few people.
In a city where public transport is widely available, one can wonder why even having a car. And if you consider a car a transportation tool and you don’t care for it, why bother? A car is a car, a dish washer is a dishwasher. In the midwest, public transportation is next to nothing. Where we live (in the state of Misery), you really NEED a car. In fact, since we both work, we need 2 cars. Car pooling is not an option. We make in total $60K a year so we are far from rich. Fortunately we have no revolving credit card debt and no student loans and a affordable mortgage on our small home, but other than that, things are not easy for us financially. There is no way that 10% of our gross income can take care of 2 cars AND their aggregated costs of car ownership. We always had older cars and paid for them, but one of them really gave us trouble to the point where my wife and kid got stranded in a not so kosher neighborhood. It wasn’t fun. And this was the moment where we sat around the table. The kids went from 2 hobbies to one, we squeezed some on our household budget and we replaced the lemon with a CPO Toyota Corolla (No more American). Simple but reliable and transportation Thanks to Corona we actually got a good deal, also in terms of finance. Our car payment is about $250 per month for 5 years, but a Corolla of a couple of years old should last 15 years with due maintenance. Actually, the goal is that this car will stay in the family for the kids. This is the first time that we ever took out a loan for a car, but my wife in particular wanted something more reliable after that episode. You got to understand, for a lot of people, where money is tight, cars are needed depending on locality and work distance. The 1/10 rule, as well as the “car per salary” table is ridiculous for most working class families without reliable public transport. Well, at least I got a raise, which was not expected in these weird times.
Seems to me you guys are making thoughtful and responsible decisions given your situation. Not everyone can get an MBA and score a finance job that will skyrocket you to the top 10 and likely over time top 1% of average annual income.
Your mistake is to be concerned with the price of the car compared to Total Cost of Ownership (TCO).
If you buy a complete piece of crap used economy car in order to stay under 10% – then you’ll be spending more on gas, repairs, etc.
TCO analysis is CRITICAL.
I recently bought a Tesla Model 3 for $40k – intending to keep it for more at least 5 years. Multiple studies have shown that over 5 years, TCO for the Model 3 is less than a $25,000 Acura or Corolla.
Since I don’t earn $400k/year – if I took your advice, I’d be spending MORE money on a $25k car.
Once you follow the 1/10th rule of car buying, the TCO becomes mute because you can easily afford all the costs that come your way. Nothing wrong with a $25,000 car!
I got a 2017 Corolla with 23,000 miles for $13,599. Toyota’s will last well over 150,000 miles and I financed at $205 for 48 months with about 5,500 down(from bonus from work). I MUST be at work, and I help take care of my elder mother so I can’t risk having a car that will break down even for a few days. I have bought used beaters and I will never risk being broken down on the side of the road again. I spend 13% of my monthly income pre tax on my car and my insurance combined and some may say that is too much. I am willing to pay a little extra for the peace of mind that comes from having a reliable car in my driveway. I get the lower price of the car means I can afford repairs but I would rather put that on a low monthly payment over 48 months on a very reliable car over continuously poring money into a bottomless pit on wheels.
For many people, a car is a need more than a want. It should be budgeted as such like rent and food. The 10% rule works for financial freedom. Seems to make more sense to apply it to lifetime earnings. For example, someone making 50k/yr is 1.5m over 30. That’s 150k or 5k/yr over 30 in lifetime for car expenditures (insurance, gas, payments, etc). So yeah, you can buy a 50k car off 50k salary. Two or 3 of them over 30 years. Of course, you can also lower the percentage to 5% of lifetime earnings for added freedom. Wouldn’t be impossible to drive two 35k cars for 30 years. Metrics also changes if you’re not trying to work for 30 years.
lmao at the article and comments. Advice is especially useless unless in an urban setting. A good saver can easily spend 50% of their ONE YEAR earnings on a conveyance that will last them MORE THAN 10 YEARS. With everyone offering 0% APR, the average would then be 5% year, which can easily be budgeted for most. You worked in finance? Yikes!
I have regretted a fairly expensive car purchase. It was paid for in cash, so it wasn’t a loan issue. More the opportunity cost of investing the money. Ultimately I decided it was a sunk cost since I’d lose so much selling it and just drive my money out of it.
This article seems odd to me, surely a 10% rule would be spread across the monthly payments? Who pays off their car in 12 months? Admittedly I only skimmed the article.
My wife earns of north of 250 and bought a 50k glc, I earn the same and have a 2013 A4 that I didn’t pay much for (25k if I recall), but If I spent 60k on my next car, it’s not a stupid amount of money. I think I read something like if you want a 30k car you should earn 300k, that’s too funny.
To the person that wants the Mustang in their 20s, crack on. You are only young once!
Some people spend more on cars, some people spend more on clothes or food. Some people spend more on a big house (though an appreciating asset, bigger houses also cost more to maintain). One thing is for sure, you cannot take your money with you in your grave. And nobody knows when he/she is going to die. Not even FS. It can happen sooner than you think. But spending your money wisely and with due consideration is the key. Of course, having a proper retirement plan is a must. Paying off credit cards, students loans etc is key for financial success. I have a government job with a decent retirement plan. I don’t drink (alcohol), don’t care for fancy clothes (Goodwill has surprises, try it out!), I don’t smoke, have an ordinary sized home. No revolving credit card debt, no student debt and neither does my wife. So after all these years driving old sh1tty cars, 2 years ago, I bought a nice brand new $32K car that came from $40K due to years end model, at 0.9% for 5 years. Wife said, go for it!. So now we spend about 15% of our monthly income on cars (payment, insurance, gas). We can easily afford it and I enjoy every drive in my new car. You only live once, remember that!
I’m curious of the writer’s input on my situation, as I do not technically follow this 10% rule but I think of myself as financially responsible: I really enjoy driving and working on cars, and my car is a large part of my monthly entertainment.
I’m in my mid 20’s, single, make 120k a year, save 2k every month for retirement, have an emergency fund and no debt, and am saving up for a house to buy in my early 30’s. I am planning to buy a used low milage 2018 Mustang GT for around 30k in cash. I feel like I can afford it, even though it is technically more than 10% of my gross income as I am meeting all of my other savings goals, have plenty of money left over in my budget after planning for the increased gas, insurance, and maintenance. What do you think, acceptable or stupid?
I think it’s a bad move. I understand loving cars in your 20s. I loved the 5.0 Mustang GT from 1990 myself back in the mid-90s.
But don’t bank on loving what you do in 10-20 years. You’ll want options and I recommended building your taxable investment accounts to build as much passive income as possible.
At the end of the day, you want FREEDOM. And money buys freedom. And freedom is way more valuable than money or a car.
At least challenge yourself to make more than $120K for 1 year if you want to buy a $30K car.
Considering our lives basically revolve around our jobs and money, what’s the point in making money without spending it on things you enjoy? The dude is still saving 2k a month and clearly has solid financial plans for his future.
Your advice should be given to people who only want to indulge in their hobbies during retirement.
Joe, if you’re reading this I say go for it man. As long as you know you can afford it then life is way to short to not treat yourself and have some fun. I got myself a golf gti and it makes me smile every damn day. I’m sure your mustang will do the same :)
I love the FS, but I have to go with McKenzie on this one. I am a car guy also so I may be partial. The thing is that you are both right. The FS approach is like scoring %100 on a test while McKenzie’s and the original OP’s approach scores you a healthy %92. Now this is where we get into diminishing returns. 100 percent is awesome but the effort to go from 92 percent to a 100 will be way more that 8 percent. Now is 50+ present more effort, energy etc worth it to achieve the remaining 8 percent, is the ROI worth it? For me I am usually happy with my 92…but again I am not shooting for greatness
Love this article. First car after graduating professional / graduate school was a slightly used Mercedes for $42k when I was $250k in student loan debt with my wife. I sold the car after enjoying it for 2 years when I purchased my first home.
Following a rule similar to this, I delayed vehicle gratification for the next 12 years and I’m $3 Million net worth wealthier. It took time to accomplish my investment goals after seeing my household income increase from $250k to $1 Million+ per year over this period.
A large car payment would have been a barrier along the way no matter how much I tried to justify based on annual income. Now, I’ve got a growing financial nut and a 5% net worth number to work with. Unfortunately, I care less about cars, my wife gets a company car, and I get a car allowance. I drive a used Toyota and don’t care about all the Range Rovers and luxury cars dropping off kids at school in the morning. I’m content knowing that I could quit my job and survive for 20+ years based on my monthly expenses or pay cash for any of the vehicles that I typically see if I desired them that much.
Nice! What is it you do that earns you guys over $1 million a year?
Don’t knock the Range Rover. I love mine! It’s the perfect family car and also the perfect car to take up to Lake Tahoe during the winter.
But such an environmental disaster. Consider a Rivian instead: FAR more enviro-responsible, capable of anything the road to Tahoe could throw at it in any season, and priced at $75k.
On the positive side, thank goodness the coronavirus and the 2+ month long global lockdowns have done more for the environment and global warming than ever before.
Ending globalization would be a permanent solution to waste and environmental degradation. How much would a 65″ TV made in The U.S., and not in The PRC’s CCP owned, non profit manufacturing complex (search: Category: China Government Owned) cost? If The U.S. were to manufacture more of its own things, it would also be more likely that people would repair things, instead of just throwing them away, and order another from 7,000 fossil fueled miles away.
Lincoln’s economic advisor, Henry Charles Carey would be rolling in his grave at the decline of his country since the financial sector has been steering it to deindustrialization, especially since 1971.
@Marty Frazer You ignore the fact that a 65″ TV made completely in the US would cost 3x as much as what’s available now, and would still only last 5 years on the top end, because capitalism.
The US has pooped the bed pretty hard on quality items they manufacture. There’s almost nothing that the US makes that other countries don’t do as well/better, and cheaper.
Since most of the nation’s electricity is derived from natural gas and coal, The Rivian is a fossil fueled car, and a lot of CO2 is produced just to make the batteries, alone. There is a woman who’s had an old, 1950s Chevy for something like a half century. In 50 years, the average EV owner might have gone through 4 or 5 cars, even if they maintained it very well. If everyone were like that old woman, however, we could have 75% fewer factories producing cars, and most of the parts of those cars. It would be better for the environment to get a low mileage, gasoline truck and make it last a few decades.
Replacing a battery every 10 years that is charged at home via solar uses far less fossil fuel than consuming them on the regular for the same amount of years. And it is a step in the right direction and as many of us as possible must each take those steps as we can to begin turning the ship away from the iceberg so to speak. . . Of course they are not perfect – yet – but they remove at least one major portion of excessive gas and oil from our world. Plus those Rivian suv’s look like tanks – they will last.
Be on the right side of history and make an effort.
I think a lot of other things should be taken into consideration and the rule should be adjusted to suit personal situations. If I make $100k a year by myself, I should most definitely be able to own a brand new Corolla or Camry that costs about $20k. I would put in a nice down payment, pay about $200 a month and pay off in 6 years and realistically expect to own the car for 15+years. At $100k salary, I wouldn’t just be buying a car, I will also have other expenses in my life. What if I’m someone who spends frugally in those other areas of expenses? Should I not be able to afford a better car if I cut down on other expenses? If my peers are spending $50-$100 a month at Starbucks but I’m not; if my peers are spending $200 a month eating out with coworkers for lunch but I’m not; if my peers are spending $300 a month on clothing and makeup but I’m not, should I not be able to afford a better car? These are just examples of course, but the point is we all get to choose how we want to spend our money. I think buying a nicer car that I feel good about driving and will be driving for as long as it runs is a good investment and it makes me happy.
I agree that there are really good deals out there for buying used cars and they will carry you for many more years to come but there are also bad deals out there where your car breaks down… say… 2-3 years down the road. As much care as you might take in buying that used car, sometimes you just don’t know whether or not there are hidden problems. I would rather buy a reasonably priced brand new one, have my peace of mind and drive that car for what it’s worth. Some people may disagree and that totally and completely fine. The point is we all think and behave differently! We have to make decisions that make sense for us. It’s all about balance.