If you’re searching for a new car and planning to buy one soon, you need to know all about the 20/4/10 rule. Here are all the details.
Buying a car is a long term plan. Whether you want to buy a small car, a truck, or an SUV, you need to make sure you have the budget for it. No matter how much money you want to spend on a car, you need to make sure you’re spending a reasonable amount based on your income and budget.
The 20/4/10 rule helps to determine if you can afford a car if you can put 20% down, get a loan term of four years or less, and if your total transportation costs will be less than 10% of your income.
By using the 20/4/10 rule, you can make sure you’re not spending too much money on your car. You can also take some stress away by ensuring you’re not going into unnecessary debt when it comes to taking out a car loan.
Using the 20/4/10 rule will help you determine if you can afford a car without it affecting too much of your budget and income. Taking out a loan that is too big or has a long payback term can put you under too much stress and negatively affect your budget.
If you aren’t sure if you can afford a car, here are the rules to follow:
Transportation costs include all the things you will need to spend money on for transport including gas, not just the monthly car payment.
This rule helps you in many different ways. To begin with, it determines if you are able to put down a high down payment on the car. If you do not have a down payment on the car, you will find that the car depreciates rapidly and you might get upside down on your car loan. This means you will not be able to sell it with a high value. If you want to sell it when you are still making monthly payments, you will find that you owe more than what you can sell it for.
If you’re able to secure a four year car loan, you will be able to pay it back quickly. A loan that is longer than that will affect your future budget and will keep you stagnant financially. Keeping transportation costs below 10% will ensure that the portion of your budget for the car does not dominate your expenses.
Keep in mind that this rule is only a guideline. It might not work for everyone. If you’re not sure what you can afford, you might want to talk to a financial advisor to see if there is enough room in your income to afford a new car payment.
Some people might also want to spend less money on a car, so they have more room in their budget to travel or buy a home. Others might be willing to spend more on a car because it’s something they truly value.
This rule might seem hard to understand if you aren’t exactly sure what your budget is or if you don’t know how much you spend on transportation. If you haven’t already, sit down with your income and expenses and create a monthly budget.
Next, you will need to determine the purchase price of the vehicle that you want to buy so that you can determine what 20% is for the down payment. You will also need to get an estimated interest rate and the total cost of financing. Then you can determine your monthly loan payment, including the interest fees.
You will then need to determine how much money you spend on transportation each month. Make sure to factor in fuel, maintenance, insurance, and anything else you will spend on the car monthly. The monthly loan payment will also be included in this.
The final step is to divide the total cost of the car by your monthly income. Some people use their gross income or their net income. Choose whichever one works best for you.
Although the rule might seem pretty straightforward, it’s not one size fits all. Here are some of the most commonly asked questions to help you determine if the 20/4/10 rule is right for you.
This all depends on your personal preferences and your income. Used cars are generally less expensive. However, you don’t know the previous owners. If buying a used car, it’s a good idea to ask for paperwork and maintenance records on it.
This can help you know for sure if the last owner took good care of the car and can ensure you don’t have issues with the car in the future. If you have a low budget, you might consider a used car.
If you have some wiggle room in your budget and want a new car, you can go car shopping and see if there is one that fits your needs. Having a new car can also ensure you don’t have car issues, and some even have a warranty that will pay for maintenance in the near term future.
Going into a car dealership can be intimidating because the salesperson might try convincing you to get a car that does not fit your budget or needs. Consider having a friend or relative come with you that can keep you on the right track.
You might also want to get pre-approved for a loan, so you have an idea of how much you’re offered. This allows you to know how much room you have in your budget. You should also let the salesperson know that you plan to stick to your budget and you do not want to look at cars that are not in this category.
Yes. You always have the option of paying for a car with cash. Not everyone wants to take out a loan for a car, and that’s fine. Depending on how much cash you have, you can either buy a new car or a used car.
Most financial planners will tell you that you shouldn’t spend more than 35% of your income on a car. So, take a look at your annual income and determine how much cash you have to buy a car.
As mentioned above, you don’t have to follow the 20/4/10 rule if you don’t feel like it's good for you. If you’re in doubt about how much money you can spend on a new car, you can seek advice from a financial planner.
One common way of changing the rule is that many people get a car loan for five or six years since it lowers the monthly payment. However, this means you will pay more interest in the long run. It might seem nice to have a lower payment, but always consider the interest before diving into a car loan.
You can also adjust your monthly budget if possible. There might be some areas where you are overspending, such as if you eat out often or spend a lot of money on vacations and monthly entertainment. It’s all about deciding what is of the most value to you and if you can do it without other things in order to spend more money on a car.
Your credit score and debt to income ratio will affect the car loan you qualify for. You might not be able to get a 4 year car loan if you have a low credit score or other debt. You might also not qualify for the best interest rates if your credit score is on the lower end.
As you can see, the 20/4/10 rule is a basic rule that can help you determine if getting a car loan is right for you not. Using your income and monthly budget in addition to the rule can show you how much money you can afford on a monthly payment. Your credit score will also determine the car loans available for you.
When using the 20/4/10 rule, you will put 20% down on your car payment and ideally be able to get a loan that is 4 years or less. This allows you to cut down on the interest. You also need to make sure your monthly transportation costs are 10% or less of your income, including gas, your car loan, and monthly maintenance.