Your old car just isn't cutting it, and you're shopping for a new one. It's painful. I know - I'm car shopping right now. One of the most important questions is, "How much can I afford?"
Spending too much money on automobiles is why many young service members end up in financial trouble. When explaining affordability, we PF pros often recommend looking at percentages of pay, loan calculators, and rules of thumb. We've talked about it here at The Paycheck Chronicles here, here and here. I wonder if all the emphasis on financial education makes any difference. There is still no shortage of service members who can't make ends meet because they have an enormous car payment.
Which is why I was so delighted when my friend sent me his newest theory. He came up with a different, simple formula to consider, and even a 3rd grader can do the math:
Don't borrow more than 5 times your monthly base pay.That's it.
For example, an E-4 over 2 gets $2195.70 in base pay. Regardless of what the dealer -- or the bank, or the credit union -- tells you, don't borrow more than $10,978.50 (2195.7 times 5). Want to buy a car that is more expensive? No problem. Just save up a down payment so that your loan stays under that amount. Can't afford to save a down payment? You can't afford the car.
My friend's summary: "I'm sorry if that won't let you buy a Mustang GT, but that's what you can afford."
Now, I usually dislike it when anyone makes an absolute statement about personal financial issues. Whenever a financial advisor or educator says, "You should do this," or "you should do that," I cringe. One size fits all advice rarely fits anyone - but my friend's suggestion is so good that I might make an exception to my "no rules" rule.
It's that good.