The 20/4/10 rule: Buying A CarLAST UPDATED: June 8, 2023 | By Conrad Golly
When it comes to buying a car, it can be tempting to go for the most expensive model with all the bells and whistles. However, this is not always the wisest financial decision. This is where the 20/4/10 rule comes in.
So, what is the 20/4/10 rule? Essentially, it states that you should make a 20% down payment on a car, take out a four-year car loan, and spend no more than 10% of your monthly income on transportation expenses.
This means that if your monthly income is $4,000, your car payment and other transportation expenses should not exceed $400 per month. While this may seem like a strict rule, it can actually be very helpful in preventing you from overspending on a car.
Explanation of the 20/4/10 Rule for Car Buying
If you’re in the market for a new car, it can be challenging to know how much you can afford to spend. The 20/4/10 rule of thumb for car buying is a popular guideline that can help you determine how much you should spend on a car without breaking the bank.
The 20/4/10 rule suggests that you should make a 20% down payment on a car, take out a four-year car loan, and spend no more than 10% of your monthly income on transportation expenses, including car payments, insurance, and gas.
Here’s a breakdown of what each part of the 20/4/10 rule means:
- 20% down payment: When you buy a car, you’ll typically need to make a down payment. The 20/4/10 rule suggests that you should aim to put down at least 20% of the car’s purchase price. This helps you avoid being upside down on your loan, which can happen if you owe more on your car than it’s worth.
- Four-year car loan: The 20/4/10 rule suggests that you should take out a car loan with a term of no more than four years. This helps you pay off the car faster and avoid paying more in interest over the life of the loan.
- 10% of monthly income: The 20/4/10 rule suggests that you should spend no more than 10% of your monthly income on transportation expenses. This includes your car payment, insurance, gas, and any other related expenses. Sticking to this guideline can help you avoid overspending on a car and ensure that you can afford to make your monthly payments.
It’s important to note that the 20/4/10 rule is just a guideline, and it may not work for everyone. You may need to adjust the rule to fit your specific financial situation.
For example, if you have a high income and low expenses, you may be able to afford a more expensive car. On the other hand, if you have a low income and high expenses, you may need to spend less on a car to stay within your budget.
Why A Down Payment Is Important When Buying A Car
When you are buying a car, one of the most important factors to consider is the down payment. A down payment is the amount of money you pay upfront when you purchase a car.
It is usually a percentage of the total cost of the vehicle and is paid in cash or check. The 20/4/10 rule of thumb for car buying suggests that you should make a 20% down payment on a four-year car loan.
There are several reasons why a down payment is important when buying a car. Firstly, a down payment reduces the amount of money you need to borrow. This means that you will have lower monthly payments and will pay less interest over the life of the loan.
When you make a larger down payment, you also reduce the risk of becoming “upside down” on your car loan. Being upside down means that you owe more money on your car than it is worth. This can happen if you don’t make a large enough down payment or if you finance the car for too long.
Secondly, a down payment shows the lender that you are committed to the purchase. When you put money down, you are demonstrating that you have the financial capacity to make the loan payments and that you are less likely to default on the loan.
This can help you qualify for better interest rates and loan terms.
Thirdly, a down payment can help you negotiate a better deal on the car. When you have cash to put down, you have more bargaining power. The dealer may be more willing to negotiate the price of the car or offer you other incentives, such as a lower interest rate or extended warranty.
What kind of car do you need?
When considering purchasing a car, it’s important to think about what you actually need. Do you need a car for commuting to work or school? Do you need a car for hauling equipment or supplies?
Do you need a car for long road trips? Once you have a clear idea of your needs, you can start looking for a car that fits those needs.
Here are some factors to consider when deciding what kind of car you need:
- Size: Do you need a small car for city driving or a larger car for longer trips or hauling cargo?
- Fuel efficiency: If you plan on driving long distances or commuting frequently, a car with good gas mileage might be a priority for you.
- Safety features: Do you want a car with advanced safety features, such as blind spot monitoring or lane departure warning?
- Technology: Are you interested in having the latest technology in your car, such as a touchscreen infotainment system or smartphone integration?
- Cost: Of course, cost is always a factor when purchasing a car. Make sure you choose a car that fits within your budget and won’t cause you financial strain down the road.
Applying the Rule to Your Own Car Buying Situation
Now that you understand the 20/4/10 rule, it’s time to apply it to your own car buying situation. By doing so, you can determine how much car you can afford and make a more informed decision.
First, take a look at your monthly income. Calculate 10% of your monthly income to determine your transportation budget. This includes not only your car payment but also gas, insurance, and maintenance costs. Make sure to keep transportation costs at or below this amount to ensure you can afford it comfortably.
Next, consider the monthly car loan payment. With a 4-year loan, you should be able to pay off the balance in 48 months or fewer. If you need a longer loan term to afford the car, it may be too expensive for your budget.
When deciding between a new or used car, keep in mind that a used car may have lower monthly payments, but it could require more maintenance costs. Be sure to factor in maintenance costs when considering your car budget.
It’s also important to shop around for car loans to ensure you’re getting the best deal. A higher down payment can result in lower monthly payments, so consider saving up more money before making your purchase.
Advantages of Following the Rule
Following the 20/4/10 rule when buying a car has several advantages. By adhering to this rule, you can:
Lower total cost of car ownership
Putting down a 20% down payment when buying a car can help you save money in the long run.
By putting down a larger down payment, you’ll have a lower loan balance, which means you’ll pay less in interest over the life of the loan. Additionally, you’ll have a smaller monthly payment, which can free up your budget for other expenses.
Less interest paid on car loans
By putting down a larger down payment, you’ll have a smaller loan balance, which means you’ll pay less in interest over the life of the loan. This can help you save money in the long run and reduce the total cost of car ownership.
Better financial stability and ability to handle unexpected expenses
By following the 20/4/10 rule, you’ll have a smaller monthly payment, which can free up your budget for unexpected expenses. This can help you maintain better financial stability and avoid financial stress.
Rising gas prices
Gas prices can be unpredictable, but by following the 20/4/10 rule, you can help mitigate the impact of rising gas prices. By purchasing a more affordable car, you’ll have more money in your budget for gas and other expenses.
Cars require regular maintenance, and unexpected repairs can be expensive. By purchasing a more affordable car, you’ll have more money in your budget for maintenance and repairs. This can help you avoid financial stress and maintain better financial stability.
Research Average Maintenance Costs
When considering the 20/4/10 rule for car buying, it’s important to factor in the cost of maintenance.
According to a report by CBRE, facilities management costs have increased dramatically through the pandemic, up 20.6% year over year in March 2022. This increase in costs is likely to impact maintenance costs for cars as well.
To get a better idea of the average maintenance costs for cars, you can check out resources such as Edmunds and Kelley Blue Book. These websites provide estimates for the cost of maintenance and repairs for specific makes and models of cars.
In addition to these estimates, you can also consider the following factors that can impact maintenance costs:
- Age of the car: Older cars may require more frequent and expensive repairs.
- Mileage: Cars with higher mileage may require more maintenance and repairs.
- Type of car: Luxury cars and sports cars may have higher maintenance costs than economy cars.
- Driving habits: Frequent stop-and-go driving or driving on rough roads can increase wear and tear on your car, leading to higher maintenance costs.
Monthly Vehicle Expenses You Should Budget For
When it comes to buying a car, it’s not just the purchase price that you need to consider. There are also monthly expenses that you need to budget for. Here are the different expenses you need to consider:
Car Loan Payment
If you’re financing your car, you need to make sure that the monthly payment fits your budget.
The 20/4/10 rule of thumb recommends that you make a 20% down payment on a four-year car loan and spend no more than 10% of your monthly income on transportation expenses, including the car loan payment. Use a car loan calculator to estimate your monthly payment based on the loan amount, interest rate, and loan term.
Car insurance is a must-have expense when you own a car. The cost of car insurance varies depending on factors such as your age, driving record, and the type of car you drive. Make sure to shop around for car insurance quotes to get the best deal.
Gasoline is another expense that you need to budget for. The amount you spend on gas will depend on the fuel efficiency of your car and how much you drive.
Use a gas mileage calculator to estimate your monthly gas expenses based on your car’s fuel efficiency and the number of miles you drive.
Maintenance and Repairs
Cars require regular maintenance and occasional repairs. You should budget for oil changes, tire rotations, and other routine maintenance expenses. You should also set aside money for unexpected repairs, such as a broken windshield or a flat tire.
Parking and Tolls
If you live in a city, you may need to pay for parking or tolls. Make sure to include these expenses in your monthly budget.
By budgeting for these monthly expenses, you can make sure that you can afford to own a car without breaking the bank.
Tips for Reducing Car Costs
Owning a car can be expensive, but there are ways to reduce the costs associated with it. Here are some tips for saving money on your car expenses:
1. Buy a Used Car
Buying a used car can save you a lot of money compared to buying a new one.
New cars lose their value quickly, so buying a used car that is a few years old can be a smart financial decision. However, make sure to have the car inspected by a mechanic before purchasing it to avoid any hidden costs.
2. Negotiate Prices and Financing Terms
Negotiating the price of the car and financing terms can save you thousands of dollars. Do your research beforehand to know the fair market value of the car you want to buy, and negotiate with the dealer to get the best deal possible.
Also, consider getting pre-approved for a loan from a bank or credit union before going to the dealership to avoid being pressured into a high-interest loan.
3. Shop Around for Loans and Insurance
Shopping around for loans and insurance can also save you money. Don’t just settle for the first loan or insurance quote you receive.
Compare rates from multiple lenders and insurance companies to find the best deal. You can also consider bundling your car insurance with your home or renters insurance to save even more.
4. Keep Up with Regular Maintenance
Regular maintenance can prevent costly repairs down the line. Make sure to get oil changes and other routine maintenance done on time to keep your car running smoothly.
You can also learn to do some of the maintenance yourself to save even more money.
Encouragement to Use the 20/4/10 Rule for Smart Car Buying
By now, you should have a good understanding of the 20/4/10 rule and how it can help you make smart decisions when buying a car.
Remember that the rule suggests making a 20% down payment on a four-year car loan and spending no more than 10% of your gross monthly income on transportation expenses.
Using this rule can help you save money and avoid overextending yourself financially. By sticking to a monthly budget for your car expenses, you can ensure that you have money left over for other important expenses.
If you can afford to pay cash for your car, that’s even better! This will save you more money in the long run as you won’t have to worry about monthly installments or more interest on a loan.
Financial experts recommend using the 20/4/10 rule for used car loans as well as new vehicles. Don’t be tempted to take out a longer loan just to afford a more expensive vehicle. Remember that other expenses, such as car insurance and maintenance, will add up over time.
When buying a car, it’s important to consider your annual income and other deductions. The 20/4/10 rule can help you determine how much you can afford to pay each month for your car expenses.
Remember that the rule is just a guideline. You may have unique circumstances that require you to adjust the rule slightly. For example, if you have multiple drivers in your household, you may need to budget for additional car expenses.
Before making a decision, use resources such as Kelley Blue Book to determine the value of the car you want to purchase. This can help you negotiate a fair price and ensure that you’re not overpaying for your desired car.
Before you go…
Frequently Asked Questions
What is the 20/4/10 rule?
The 20/4/10 rule is a popular guideline for buying a car.
It suggests that you should make a down payment of at least 20% of the car’s price, finance the car for no more than four years, and keep your total monthly vehicle expenses (including loan payment, insurance, and gas) below 10% of your gross income.
What Does The ‘4’ Mean In The 20/4/10 Rule?
The ‘4’ in the 20/4/10 rule refers to the maximum length of time you should finance your car. This means that you should aim to pay off your car loan within four years to avoid paying too much in interest.
How Is The 20/4/10 Rule Used When Getting A Car Loan?
When getting a car loan, you can use the 20/4/10 rule to determine how much you can afford to borrow. Start by calculating 20% of the car’s price and subtracting it from the total amount you want to borrow.
Then, divide the remaining balance by the number of months in your loan term to get your monthly payment. Finally, add up your estimated monthly vehicle expenses (insurance, gas, etc.) and make sure they don’t exceed 10% of your gross income.
Is The 20/4/10 Rule Pre-Tax Or Post-Tax?
The 20/4/10 rule is typically based on your gross income, which is your income before taxes.
This means that you should aim to keep your total monthly vehicle expenses (including loan payment, insurance, and gas) below 10% of your gross income.
What Is The 20/8/3 Rule?
The 20/8/3 rule is another guideline for buying a car.
It suggests that you should make a down payment of at least 20% of the car’s price, finance the car for no more than eight years, and keep your monthly car payments (including loan payment and insurance) below 3% of your gross income.
What Is The 50/30/20 Rule For Car Payments?
The 50/30/20 rule is a budgeting guideline that can be applied to car payments.
It suggests that you should allocate 50% of your income to necessities (such as housing and food), 30% to discretionary spending (such as entertainment and dining out), and 20% to savings and debt repayment (such as car payments).
How Can I Stick To My Budget When Buying A Car?
To stick to your budget when buying a car, start by setting a realistic budget based on your income and expenses.
Then, use the 20/4/10 rule (or another guideline) to determine how much you can afford to spend on a car. Research different makes and models to find one that fits your budget, and negotiate the price with the dealer. Finally, be willing to walk away if the price is too high.
How Much Can You Afford To Pay?
How much you can afford to pay for a car depends on your income, expenses, and financial goals.
Use the 20/4/10 rule (or another guideline) to determine how much you can afford to spend on a car, and make sure to factor in all of your monthly vehicle expenses (including loan payment, insurance, and gas). Remember to leave yourself some wiggle room in your budget for unexpected expenses.