How much can you afford to borrow for a car loan?
Buying a car is a major financial decision that you don’t want to get wrong. So, you need to know how much you can comfortably afford to borrow before you start shopping for a new set of wheels.
How do you work that out?
It all boils down to your individual financial situation, including your income, savings, expenses and credit history. Lenders use this information to calculate your ‘borrowing power’.
Borrowing power is the amount of money you can comfortably afford to pay back to a lender each month without it causing financial difficulties.
Understanding your borrowing power
When you apply for car finance, lenders determine your borrowing power by weighing up your monthly income against your living costs.
Many lenders use a formula called the household expenditure method (HEM) to help them with this calculation.
The HEM estimates your living expenses based on details such as your income, location, family size and the number of children you have.
Lenders then compare the HEM figure with your declared expenses, typically using the higher of the two to work out if you can afford the loan.
As rejections can damage your credit score, it’s essential to have a good idea of your borrowing power before applying for a car loan.
How to work out your living expenses
Get a clear picture of where your money goes each month by considering how much you spend on:
- Essentials – such as rent, utility bills, groceries, commuting costs and insurance
- Debt repayments – including any mortgage payments, credit card payments and personal loans
- Extras – such as eating out, takeaways, entertainment and other nice-to-haves.
Once you know your living expenses, use our car loan affordability calculator to determine your borrowing power.
Car loan affordability calculator
If you’re wondering: ‘Can I afford a car loan?’, calculators can help you run your numbers.
Simply fill in a few details about yourself (such as your salary and monthly expenses). The calculator then estimates the maximum loan amount you may qualify for and what your monthly repayments would be.
Looking for an affordable car loan? Consider these factors
Several other factors play a large role in how affordable a car loan is. These include:
- The loan’s term – the longer the length of your loan, the lower your monthly repayments. However, longer loan terms are often more expensive over time as you pay back more in interest.
- The interest rate – the lower the rate, the more affordable the car loan.
- The deposit amount – the bigger your deposit, the more you should be able to borrow.
- Balloon payments – having a balloon payment on your car loan will reduce your monthly repayments. However, you will need to budget for the additional one-off payment due at the end of the loan.
What else should you consider?
Don’t forget that car ownership comes with its own set of costs. Give yourself some wriggle room by adding your car’s running and maintenance costs to your budget. Don’t forget to include:
- Repairs and servicing