TL:DR: You should try to never spend more than 20% of your annual income on car costs. We recommend keeping it lower at 10%-15%.
Your choice of car has a huge effect on both personal freedom and your finances. For many people, a car is the second most expensive item in their budget, second to housing expenses.
But, buying a car is essentially a necessity in some parts of the country. For many of us, it could also be a crucial part of being able to do our job.
The thing is — buying a car can put a huge dent in your budget if not done properly. If you are lucky and live in an area with good public transit, you could feasibly manage without a car, but this is not a reality for most people.
When buying a car, it is important to realise you will be paying for more than just the price of the car. You must also factor in:
- Maintenance costs
- Petrol costs
- Paperwork like insurance and registration.
As it stands, a car is far from being a one time purchase. A car is a long term investment.
You also need to factor in the amount that the car depreciates in value every year. In general, a more expensive car will depreciate faster than a cheaper car.
Today we are going to talk about budgeting for a car in the UK and how you can calculate the amount of money you should spend on a car.
What Costs Will I Need to Cover?
Owning a car involves several recurring costs. Along with the initial down payment, you will also have to cover
- Fuel costs
- Maintenance costs
- Local and federal taxes
In addition to these explicit costs, you also need to factor in how much the car depreciates in value over time. Depreciation will affect the total resale value of the car and so can be considered a cost.
The very first thing you need to do is determine your monthly and annual budgets. Once you know your exact cash flow, you can allocate portions of your income to the different car costs.
It is worth noting that according to the Office for National Statistics, the average annual running cost for UK motorists is around £1,679. So if you buy a car, you should expect to be paying somewhere around this amount. Keep in mind that this figure does not include the depreciation of the car’s value over time.
If you are completely unsure of how to spread your budget, here is a quick overview of the 20/4/10 rule. According to this rule, you should:
- Make a down payment of at least 20% of the car’s value
- Finance for no more than 4 years
- Spend no more than 10% of your gross monthly income on vehicle expenses.
The 20/4/10 rule is a good place to start with figuring out your car budget. You can change these proportions based on your current financial situation, but ideally, you should hang around these ratios.
The first thing you need to consider is the down payment. Normally, the down payment is a larger sum you give upfront and then you pay off the rest of the car in monthly instalments.
In the ideal situation, you could just buy the car straight up and not have to worry about down payments or monthly payments.
Unfortunately, most people just do not have the savings to outright buy a car and so rely on loans or financing options to make payments.
Conventional wisdom holds that you should try to pay at least 20% of the car’s total value in a down payment. So, if your car’s total cost is £15,000, then you should try to shell out at least £3,000 on a down payment.
In general, the larger the down payment the better. A larger down payment means you have fewer monthly payments, interest and principal costs will be less, and you will offset the initial hit of depreciation.
Unless you can buy your car outright, you will have to make monthly payments on your car. According to the 20/4/10 rule, you should try to spend no more than 10% of your monthly gross income (pre-tax income) on principles, interest costs, and insurance.
So for example, if your monthly income is £2,500 before taxes, then you should try to spend no more than £250-£300 a month on these costs.
This is where a larger down payment comes in handy. The more you spend upfront, the less time your repayment period is which means fewer interest chargers on any loans or financing options.
Many auto finance companies let you make very small monthly payments, but the more you pay, the quicker the car will be paid off, which will save you more money in the long run.
For example, say the total value of your car is £15,000 and you make a down payment of £3,000 and make monthly payments of £250. It would take you about 48 months to pay off the rest of the car and that is not factoring any interest charges. If you had put down £5,000 as a down payment with the same monthly payment, you could pay it off 40 months, almost a year earlier.
Average Cost Of Owning A Car In The UK
According to Motoring Research, the average UK motorist spends about £162 on car costs per month, not factoring and loan or financing payments.
Aside from monthly payments, you need to factor in running costs for the car, including maintenance and fuel. This figure can differ heavily depending on how much you use your car, but .
About 70% of this amount is for repairs or breakdown, 25% on fuel, and the other 5% on miscellaneous costs like cleaning.
You need to be careful about cutting costs in this area. While you can forgo routine inspections and drive until your tank is completely empty to save a pound or two, failing to get routine maintenance can ultimately transform into a huge problem that will cost you a lot in the future.
As with many things, prevention is better than a cure.
Let’s talk about depreciation. Like any consumer good, the value of a car decreases with time and use. Depreciation is one of those “hidden” costs that is not immediately recognizable on your monthly statements but still has an impact. Ultimately, depreciation affects the resale value of a car.
New cars experience the most depreciation.
In fact, the value of a new car can decrease by 10%-20% the moment you drive it off the lot and 15%-20% each year afterwards.
Most cars depreciate in value by 60% by the 5th year. This means that if you sell your car within 5 years of buying it you will lose almost half the car’s original value.
For example, if you buy a brand new car for £20,000, then by the fifth year of owning, it will only be worth about £9,000. Depreciation should be considered a cost because it decreases the total value of your financial assets.
Depreciation is one area where buying a used car can really help.
You can save nearly 20%-30% by buying a used car that is a year old. Used cars tend to depreciate slower than new cars so you will be able to recoup more of the original cost when you resell.
Here is how you can calculate the approximate depreciation on your car:
- First year: Price of new vehicle x 0.75
- Second Year: Value after the first year x 0.825
- Third year: Value after the second year x 0.825
And so on for each consecutive year. Generally, depreciation begins to level off after about 7-10 years, so there is a more or less minimum value your car will fall to.
Also, if you have a job that you have to use your car for, buying a cheaper used car will save you a lot more in terms of depreciation.
If you have a job that requires you use your car every day, then the best option might actually be to buy a cheap used car and run it into the ground instead of buying a more expensive car and worrying about maintenance costs and depreciation.
Putting It All Together
Let’s summarize everything we have talked about so far. Following the 20/4/10 rule:
- Spend at least 20% of the car’s value on your down payment
- Finance the car for no more than 4 years
- Spend 10% of your monthly income on monthly payments
Adding all these values together, you should be spending around 20% of your gross annual income on your car.
The median annual income in the UK is £28,677, so if you make the median income you should try to spend around £5,500 on your car expenses.
If you need to be extra frugal, we recommend lowering this percentage to 10%-15%. Keep in mind that you will be paying more in your first year due to any down payments.