What Is the 20/4/10 Rule for Car Buying?
It can be all too easy to buy a car you can’t really afford because you’re lured in by that new-car smell. One way to ensure you’re making a sound financial decision when buying a car is to use the 20/4/10 rule.
The 20/4/10 rule helps you determine the ideal amount to spend on a car by specifying how much down payment to offer, the length of the loan term and the percentage of your income to devote to car-related expenses. Following this rule can help you buy a car you can afford and enjoy for years to come.
What is the 20/4/10 rule?
Buying a car is a big decision, but it doesn’t have to be stressful. The 20/4/10 rule can help car buyers decide whether they’re in the financial position to buy a new car. To apply this rule of thumb, budget for the following:
- A 20% down payment
- Repayment terms of four years or less
- Spending less than 10% of your monthly income on transportation costs
By offering a significant down payment, limiting your loan term and keeping your car expenses low, you can be sure that you’re not overspending on a depreciating asset.
How does the 20/4/10 rule work?
While it may require some extra planning on your part, the 20/4/10 rule for buying a car is pretty straightforward.
20% down payment
A down payment on a car is money you pay upfront to decrease the amount you need to borrow when purchasing a car. The 20/4/10 rule encourages consumers to put down at least 20% of the total price of their vehicle, which will lower the overall amount you borrow and reduce the interest you’ll pay over the life of the loan. While there are no-money-down car loans, not providing a down payment can cost you more in the long run.
One important reason for putting money down is that you’ll reduce the likelihood of owing more on the car than it is worth, also known as becoming upside-down on your car loan. You may also get a higher annual percentage rate (APR) if you don’t provide a down payment, as your lender would view the loan as a higher risk. Your APR measures how much your loan will cost, including interest and fees.
LendingTree’s auto loan calculator can help you calculate how much you may be able to borrow.
Choose a four-year term or less
Your loan term determines how much time you have to repay your debt. The 20/4/10 rule suggests that you should aim to finance your car for no more than four years, or 48 months.
If you borrow a short-term car loan, your monthly payments will be higher but you’ll pay less in interest. On the other hand, if you take out a long-term car loan, your monthly payments will be smaller, but you’ll likely pay more in interest. By limiting the length of your loan term, you’ll avoid paying more in interest over time and you’ll own your car sooner.
Keep transportation costs below 10%
The final piece of the 20/4/10 rule refers to the percentage of your gross monthly income that you should spend on car-related expenses. Between your auto loan, car insurance costs, fuel and repairs, owning a car can get expensive fast. In 2021, U.S. households spent an average of $10,961 on transportation, according to the latest data from the Department of Transportation.
When considering all the money you’ll need to invest in a new car, try to keep your total transportation costs to 10% of your monthly income or less. This way, you can afford to keep up with payments and still cover any unexpected costs.
Pros and cons of the 20/4/10 rule
The 20/4/10 rule can provide financially sound guidance when it comes to budgeting for a car loan, but it’s not a hard and fast rule that’ll work for everyone.
Because you’re putting down a large down payment and agreeing to short repayment terms, this rule can help you save money on your car loan.
It can help teach you good financial habits, such as saving and budgeting for a large purchase.
A large down payment and short repayment term can help you pay off your car loan faster.
The rule doesn't take into account your credit score, which can impact the APRs lenders offer you; this can make it difficult to qualify for a loan if you have bad credit, even if you have a 20% down payment.
Factors like inflation aren't taken into consideration, which can make buying a car much more difficult.
Some consumers may have a limited budget and can't afford to save up for a 20% down payment or take a short-term loan.