You’re finally ready to purchase your first car, but with the way prices are these days, you’re considering financing a vehicle. When you go to visit the car lot, there are rows and rows of cool cars that strike your fancy, but you begin to get sticker shock once you see the price tag on these new vehicles.
It’s easy to get roped into a high car payment when you don’t have a general guideline to go by. How can you know how much you can afford? Once you factor in housing, food, and other basic living expenses, how much should you set aside for transportation costs?
This is where the 20/4/10 rule for car buying can come in handy by offering a simple guideline to follow when you are looking to finance or refinance your auto loan.
What is the 20/4/10 rule?
Anyone in the market for a new car has probably heard of the 20/4/10 rule. But what exactly is this rule, and how can it help you save money? The 20/4/10 rule has three factors to follow when buying a car:
- 20- you should put down 20% of the total car purchase price for a downpayment
- 4- you should finance your car for a loan term of no more than 4 years
- 10- you should aim to keep your car expenses to less than 10% of your gross monthly income
Is the 20/4/10 Rule Sensible?
This rule formula approach will help you stay within your budget while still getting the features and quality you want. Here’s what you need to do:
First, choose a car that costs less than 10% of your monthly income. This will ensure that you can easily afford your car payments. Car costs don’t only mean your loan amount. This also includes car insurance, petrol, maintenance, car washing, parking costs, and any other car expenses that you may have.
Next, get a loan with a term of no more than 4 years. This will keep your monthly payments low and help you pay off your loan faster. You won’t be paying on your car note forever. 4 years is shorter than the typical 60-month recommendation, and it ensures that you won’t still owe on your car when it has depreciated due to natural wear and tear.
Lastly, put at least 20% down on your car. This will lower your monthly payments and help you avoid being upside down on your loan (owing more than the car is worth). When you buy a brand-new car, your car depreciates as soon as you drive it off the lot. By paying down 20%, you can ensure that you never have a loan on your car that is worth more than the actual car.
By following the 20/4/10 rule when buying a car, you’ll be sure to stay within your budget and get a great deal on a high-quality vehicle.
How to Calculate the 20/4/10 Rule to Determine Your Personal Buying Budget
Let’s take the average cost for each of these categories in the UK and then determine how much more you can afford to pay on a car loan.
- Car insurance: £35
- Car taxes and maintenance: £108
- Petrol: £106
The average cost of a new car in the UK is £20,000. According to this rule, this means you would put 20% down, which would be £4,000, and finance the remaining £16,000 at an average interest rate of 6.7%, over a loan term of 4 years.
Using this calculation, your monthly payment for your car loan would be £379.46.
Then, you have to add back in the other monthly car expenses that we previously discussed, and now your monthly car expenses are sitting at £628.49 a month.
To afford this car, you would need to make a monthly salary of around £6,300.
Cons of using the 20/4/10 Rule
The 20/4/10 rule is a simple guideline for car buying that can help you stay within your budget. The rule states that you should put down a 20% down payment, finance the car for no more than 4 years, and keep your monthly payments at 10% or less of your gross income.
However, this rule assumes that you have a good income and can afford to put 10% of your pay towards your car payment. For many people, this simply isn’t possible. If you don’t make a lot of money, you won’t be able to afford much car on 10% of your income.
In this case, you might have to save up more than 20% for your down payment. Even if it takes longer to save up the money, it will be worth it in the end if it means that you can stay within your budget.
Other exceptions to consider are if you have a trade-in with significant equity, you may be able to put down a smaller down payment. Or, if you’re buying a used car that is several years old, you may be able to finance it for a shorter term without increasing your monthly payments above the recommended 10%.
Methods to work the 20/4/10 rule into your budget
If this rule doesn’t work with your current income, here are a few tips to make it fit your unique situation:
- If you can’t dedicate a full 10% of your gross income, try to increase your down payment percentage to 30-35%
- Consider purchasing a used car instead of this year’s latest model
- Stick with the base model and skip all the bells and whistles
- Keep your current car and save up longer for a downpayment by paying yourself the would-be car payment.
The 20/04/2010 rule is a guideline that can help you budget for your next car purchase. By following this rule, you can avoid being upside down on your loan and keep your monthly payments manageable. However, there may be exceptions to this rule depending on your individual circumstances. Ultimately, it’s important to work with a qualified financial advisor to find the best financing option for your situation.