Afford Your Auto Loan with a 50/30/20 Plan
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UPDATED: Feb 16, 2012
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Oftentimes prospective auto loan borrowers wonder how much they can afford when it comes to financing a vehicle. What percentage of one’s income is the perfect amount to ensure one doesn’t fall into default? Default usually occurs when borrowers take money out for an amount outside of their means to repay. The weight of the auto loan begins to weigh on them after a few months, and then the inevitable default occurs. While unexpected expenses and emergencies may be unavoidable, if borrowers follow a responsible budgeting plan, they can maximize their potential to pay off their car loan regardless of what life throws at them.
The 50/30/20 Budgeting Plan
Proposed by Liz Weston, a finance writer who devised this plan after reading Harvard Bankruptcy professor Elizabeth Warren’s money-management book, the 50/30/20 plan divides one’s needs, wants, and savings up into different pre-designated allotments. According to the plan, needs should consume no more than 50 percent of one’s after-tax income, wants should be given 30 percent, and the remaining 20 percent should be saved. The 50/30/20 plan is helpful not only for auto loans, but for budgeting and planning for any and all other expenditures as well.
Let’s take a more in-depth look at how it works.
Needs: The Bulk of One’s Spending
Needs account for everything that is a “must-have.” But regardless of what some may think, those high-heels in the shopping mall window are not “must-haves.” Rather, needs account for all things necessary to survival and basic necessities that many now rely on for day-to-day operations. Expenditures such as housing, utilities, transportation (car loans, gas, train and bus fares), food, medicine, insurance, education, child care, and minimum (this is important) loan payments, all account for needs.
One expense to include in the minimum loan payments category is the cost for a basic cell phone plan. A cell phone plan, particularly if bound by contract, is a loan of sorts. Even if borrowers have a plan above and beyond the basic plan, consider what it would cost if one had just a basic plan, and include that cost here. We’ll get more into the expense that goes above and beyond the basic in just a bit here.
Now after calculating all of those needs up, the total should amount to only 50 percent of what one currently makes. If borrowers find this number is higher, that’s ok for now—this is simply a goal. But keep in mind 50 percent is what is fiscally responsible, so, if possible, reduce spending in some of those areas.
Here are some quick tips on how to reach and adhere to that 50 percent threshold:
- Don’t eat out all the time. This doesn’t mean just restaurants, but fast food as well. If borrowers plan their meals out each week, a single coupon-equipped trip to the grocery store can prove to be far more inexpensive than the Jack-in-the-Box and Carl’s Jr. late-night runs. Not to mention homemade meals are much healthier, and leftovers provide a great tasting, inexpensive meal the next day.
- Cut back on utilities. Open windows and use blankets instead of blasting the AC and heater.
- Downgrade the contracts. Instead of paying for cable, consider purchasing a Netflix or Hulu subscription. Many shows and movies are available on those two streaming services, and users don’t need to adhere to any time schedule. Additionally, even if a borrower purchased both subscriptions, it is often cheaper than the very lowest cable plans.
Wants: Our favorite
Wants are all of those items that we don’t need, but that we often think we do: clothing, gifts, vacations, alcohol, video games, movies, make-up, and phone plans that go above and beyond the basic. While some things are necessary from this category, such as clothing, we have to assume those interested in using this plan already have at least some clothes. Anything additional is a want, and should be budgeted for by only setting aside 30 percent of one’s after-tax income.
Any additional payments made towards outstanding loans above the minimum requirement should be put into this category as well. For instance, to calculate an expensive cell phone plan, put the basic plan price in the needs category, and then the difference between that price and the “smart-phone” price in this wants category.
Cutting back in the wants category is easier than the needs, but it may not feel like it:
- Reduce cell phone plans. Do people really need to spend $100 a month on a cell phone plan? Chill out on the talking or sign up for a plan that allows for circle-of-friends. All of the big companies offer some sort of service that grants borrowers a few friends in which all calls to and from them are free. Saving $10, $20, or $30 on a cell phone bill can equate to hundreds by the end of the year.
- Don’t buy this season’s new styles. By all means, purchase new clothes, but only if the 30 percent set aside can accommodate the price. Otherwise, save up!
Savings: Be responsible for the Future
If 20 percent of borrowers’ income is set aside, not to be touched, then bankruptcy and debt will soon become foreign words to their ears. This amount is meant to be used for future purchases, such as down payments on car loans or houses. It is set aside to help borrowers through tough times, job layoffs, emergencies… you know, life.
Where do car loans fit into this?
An auto loan is a basic need, since a vehicle will satisfy one’s need for transportation. In order to accommodate for a car loan payment, reduce needs’ expenditures to below the 50 percent threshold, and whatever amount is left can be put towards a the vehicle financing.
For example, imagine a couple who makes a collective $6,000 a month after taxes.
Every month they spend $1,000 on rent, $150 on utilities, $500 on food, $100 on two basic cell phone plans, $300 on an education bill of, $400 on medical insurance, $50 on medical prescriptions. They’re currently spending $2,500 on their needs.
But their needs allotment can equate to a total of $3,000, so they have a full $500 to devote to a monthly car loan payment and car insurance. Apply this same philosophy for any other type of loan as well.
By adhering to this 50/30/20 plan, borrowers can assure themselves they are making auto loan payments that they can afford, while simultaneously saving for a rainy day.