My usual answer:
“Whatever you can afford to buy with cash and still have 3-6 months of living expenses in an emergency fund.”
Cars are notorious for losing value. In fact, brand new cars are one of the worst investments you can make, losing on average between 50% and 60% of their value in the first four years!
Annually, I see 3 or 4 couples who are struggling financially because they are trying to make car payments on one or more vehicles that are worth less than they owe. It is almost always a bad idea to take out a car loan, even if you are charged extremely low interest. Unless you already have the money saved making at least some interest, and the car dealer is unwilling to give you a discount for cash on the barrel, you should stay away from buying a car on time. If hard financial times hit (e.g., you lose your job, get hurt, incur an unplanned expense, etc.), you don’t want to be saddled with a financial obligation greater than the value of your car(s).
If you only have $3,000 for a down payment on a car, and you were prepared to pay $400.00/mo. anyway, then I recommend buying a $3000 car and saving $400/mo for two years. At the end of the two years, sell your $3000 car for $2500 and buy a nicer car for $12,100 with cash ($2500 + (24 months X $400)). Drive the $12,100 car for two years, saving $400/mo like before, and then sell it; this time for $8,500 (remember, newer cars depreciate more). With the $9,600 you saved over two years, you can now afford a car that costs $18,100. Do this every two years, and in about six years you will be driving relatively nice vehicles, and you won’t be saddled with car payments. Should hard times hit, you can use the $400/mo for living expenses, and you can wait until things get better to upgrade your vehicle.
If you have kids, the last thing in the world you want to do is spend a lot of money on a new car. Even the most anal parents are going to find the back seat filled with cheerios, juice box stains, and caked mud from young athletes crawling in after sports practice. Even if your own kids are good about keeping your car clean, the other kids in the neighborhood car pool aren’t going to be quite so conscientious. Lest you become the Nazi soccer mom or are addicted to mood altering drugs, I encourage you to buy a used but reliable car you won’t stress over if your kid spills his Sippy cup or vomits in the back seat.
In America, our wheels are a status symbol, but there is nothing impressive about being stressed out owning cars we can’t afford. If peace of mind and achieving financial security is important, then paying for vehicles with cash is the only way to go.