Purchasing a car can be a stressful experience – and a costly one at that if you’re not doing the proper due diligence.
Often times consumers bite off more than they can chew… and suddenly that dream car sitting in your driveway becomes a financial NIGHTMARE.
Well, no need to fear! Purchasing a car doesn’t have to be stressful OR costly. Using the 20/4/10 rule, you can quickly find out how much car you can afford.
I need a car, but I can’t afford to buy one with all cash. What’s my best option?
If you can’t purchase a car using all cash, that’s OK.
In America, most consumers finance their vehicle purchases. Do they always do the numbers and finance what they can afford? That’s debatable.
In fact, based on data from 2019, American’s held over $1.3 trillion dollars in auto debt alone. On average, they owed a balance of $19,231.
These numbers are STAGGERING, but rest assured you can purchase a car intelligently using the 20/4/10 rule.
What is the 20/4/10 Rule?
Great question! Let’s first breakdown what each number represents within the 20/4/10 rule.
20 = The percentage you should put down on the purchase of your car.
- Example: A car has a price tag of $25,000. Therefore, your down payment should be $5,000. ($25,000 * 0.20 = $5,000).
4 = The maximum term of your auto loan.
- 4 years, or 48 months.
10 = The ideal percentage of your total monthly income that should go towards the cost of your car (including gas and maintenance).
- Let’s say John the car buyer makes $60,000 a year, which equates to $5,000 per month. John then has $500 a month to work with to cover the cost of his car payment (along with gas and maintenance). ($5,000 * 0.10 = $500 per month).
Now that you know what the numbers stand for in the 20/4/10 rule, you can begin to use the rule to determine how much car you can afford.
BONUS: We put together a real car buying scenario. Who got the better deal?
|Scenario 1: Tom||Scenario 2: Jerry|
|Vehicle price: $25,000||Vehicle price: $25,000|
|Down Payment: $0||Down Payment: $5,000 (20%)|
|Interest Rate: 4.7%||Interest Rate: 4.7%|
|Loan Term: 60 Months||Loan Term: 48 Months|
|Monthly Payment: $468||Monthly Payment: $458|
|Interest Paid: $3,100||Interest Paid: $1,978|
In this situation, Jerry is the clear winner as his 20% down payment allowed him to shave a year off his loan repayment period AND save just north of $1,100 in interest he would’ve had to pay if he chose to finance his vehicle purchase the same way Tom did.
But wait, we’re not finished yet!
Because Jerry was able to shave a year off his loan repayment period, he was able to bank an additional $458 per month for 12 months. In total, he banked $5,496 dollars.
Taking it one step further: Buying a car with all cash.
Let’s say Jerry takes that $5,000 down payment and instead purchases a beater for $5,000.
That means he isn’t making that $458 monthly payment for 4 years straight. Instead, he’s banking that cash and preparing to use it on a new purchase in 4 year’s time.
Because Jerry chose to purchase a $5,000 beater and not pay $458 per month for 4 years straight (48 months), he banks approximately $22,000 in cold hard CASH.
Now Jerry, after delaying a little gratification for 4 years, can purchase a $22,000 car if he so chooses… with ALL CASH.
Yes, of course there is maintenance, insurance, gas, and other variables that fit into the car buying mix.
It’s impossible to account for every single detail. The purpose of the 20/4/10 rule and these purchasing scenarios is to get you thinking in the right direction, to reshape the way you approach car buying.
Now that you understand the 20/4/10 rule, you can play with the numbers and determine how much car you can really afford.
Happy car buying!