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Question for the Money Doctors

Question submitted on May 14, 2010.

Question

I'm thinking about buying a car and want to know if you think I can afford it. The car will cost approximately 21,000. My car if traded in will probably fetch 2,500. I have approximately 18,000 in cash, but want to keep some as a safety reserve. I also have some stock I could sell if need be. I was thinking of paying cash for the whole thing, but want to know if that might be too risky as I wouldn't have much in the way of emergency reserves. Would you advise financing a small portion of the purchase? Can I even afford this car? My only other liability is a student loan at around $6000 with a very low interest rate. I also own my home and have a mortgage. I currently earn $45,000 base salary, but can get commission on top of that (i also have no dependents). I would estimate that I may make 55k to 60k this year. I value your opinion.

Thank you, Jeff

Answer

Jeff, first you may want to examine the reason for getting a new car.  Is the difference in operating costs enough to warrant getting rid of the old one?  You'll also want to consider the increases in your auto insurance bill and potentially vehicle property taxes because of the increased value of the new vehicle.  In fact, if you have not done so already, you may consider dropping the comprehensive coverage on your existing car.

I wouldn't recommend depleting your emergency fund.  You should keep enough of an emergency to cover all your monthly expenses for 3-6 months.  I'd lean closer to the 6 months since approximately 1/3 of your pay is commission based.

As for the affordability of the vehicle, I'll give you a couple of rules of thumb.  Your consumer debt payments (vehicle payments, credit card payments, student loans, etc.) should not exceed 20% of take home pay and all monthly payments, including the mortgage, should not exceed 36% of monthly gross income.

If your existing car is servicable, you could set money aside each month to save an additional down payment amount.

Good luck with your decision.


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