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Should we buy cars for more than x percentage of our income?
A mentor of mine, who lives on the west coast and is fully immersed in the scene, and I were chatting about finance the other day, and the topic of cars came up.
Many people fall into the category of high cash flow yet high debt-to-income ratio. They consistently chase the flashy and attractive things without considering their financial future and the impact they have now to make their future a financial breeze. They often fail to take advantage of lucrative investment opportunities that increase their assets because they rather invest in liabilities.
When you have the means to blow money on cars, does that mean you should? Maybe, if you have the following in place in this order:
You’re not living paycheck-to-paycheck.
You have more than one income source.
Your expenses do not exceed your income.
You’re not carrying debt.
You have a one-year locked and loaded emergency fund.
You’re on track with your retirement savings.
Your investment portfolio is diversified.
This recommendation also applies to those spending >$500 on a car payment.
In 2020, the average wage and salary per full-time equivalent employee in the United States was 50,000 to 71,456 U.S. dollars. Wage and salary accruals include executives’ compensation, bonuses, tips, and payments-in-kind (Source: Statista).
According to Financial Samurai, you should spend no more than 1/10th of your gross annual income on the purchase price of a car, which means plenty of us are overspending on cars.
Do we have to follow the 1/10 rule? Of course not, but it will improve your finances. Cars are one of the most expensive liabilities that American households possess.
If you’re in a healthy place financially (and have the seven things above in order), it’s fine to bend the suggested recommendations a bit and only spend 5% of your net monthly income on a car payment, which can give you a bit more flexibility.
Still, once again, you have to ask yourself whether it is worth it in the long run and for your financial health. Holding a car payment is a low risk for the average American family, especially with lower car payments ($500 or less). But always ensure you can pay that car payment if you lose income, have unexpected expenses, and not sacrifice your future financial health in return.
This content is for informational purposes only — not professional advice. Consult a qualified professional before making any major decisions.