The 20/4/10 Rule: How Does It Apply to Buying a Car?

Planning to buy a new car? Bringing home a new car often comes with excitement and joy. Whether you are purchasing your first car or your childhood dream car, it is important to understand the financial implications to make a wise decision while purchasing your new car.

When it comes to buying a new car, no one will make the right decision. Some rich people prefer to buy the car by making the full payment, whereas others may prefer to take a loan. The 20/4/10 rule is a guideline that helps new car buyers make a financially responsible decision. It gives a clear understanding of whether you are able to afford the car or not. By following this rule, you can determine how much you can afford to spend on a car, how long you should finance it, and what percentage of your monthly income you can spend on car expenses.

What is the 20/4/10 Rule?

20/4/10 is a commonly used guideline in the car buying process. It suggests that you should make a down payment of at least 20% of the car’s on-road price, finance the car for a maximum of 4 years, and the combination of car expenses and EMI must be less than 10% of your monthly salary.

Let’s understand this point with a clear example:

If you are planning to buy a Ford Mustang, which costs $1,000,000, Then the 20/4/10 rule reflects the following values:

1. Down Payment Value: 20% of $1,000,000 = $200,000
2. Finance value: $800,000
3. Tenure: 4 years
4. Total Interest Payable: $1,37,456
5. Payable amount: $9,37,456
6. Per-month EMI: $19,530

So, as per the 20/4/10 rule, the per-month EMI of your car loan must be less than 10% of your monthly income. Therefore, your monthly income should be equivalent to or more than $195,300.

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Why choose the loan tenure of 4 years or less?

The loan tenure determines the total amount of interest payable and the monthly EMI. As soon as you take out a new car from the showroom, its value gets depreciated immediately by 20%. Then, over the consecutive years, the value gets depreciated by 10–15%.

Keeping the depreciated values in mind, if you take a loan for a short period of time, you can pay off the loan faster and minimize the amount of total interest payable. Furthermore, with a shorter loan tenure, you can easily upgrade to a new car without being burdened by the existing loan.
Additionally, opting for a shorter loan tenure also allows you to save on interest charges. Also, with less loan time, you can build equity, which helps save on the total cost of the loan.

Benefits of Implementing the 20/4/10 Rule

Implementing the 20/4/10 rule is important because it helps individuals make informed decisions about their car loan. By following this rule, individuals can ensure that they are not taking on an excessive amount of debt that they can’t repay. Furthermore, it promotes responsible financial planning as it encourages individuals to choose the perfect amount of loan that matches their budget and income.

1. Minimizes Debt Burden: Making a larger down payment and opting for a shorter loan tenure helps car owners reduce their overall debt burden. It even allows them to pay the loan faster and become debt-free sooner.
2. Lower Interest Payments: The 20/4/10 rule helps individuals save a lot of money on interest payments. By paying a larger down payment, car owners can minimize the amount of interest they have to pay over the life of the loan.
3. Ease of Loan Repayment: By keeping the loan EMI under 10% of your monthly income, you can easily manage the loan repayment without any stress. It reduces the risk of missing payments and defaults, which can negatively impact your credit score.
4. Financial Discipline: This rule encourages individuals to develop financial discipline by setting a realistic budget and sticking to it. It allows them to approach the car-buying process with discipline and prudence, ensuring that they don’t overextend themselves financially. It also helps individuals to create a good credit history, which will benefit them for future loan applications and financial endeavors.
5. Encourages Savings: Spending a larger amount on down payments directly encourages individuals to save more money. It fosters a culture of financial responsibility and helps individuals prioritize savings over spending.

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Conclusion

Following the 20/4/10 rule while buying a new car can help you make a wise financial decision and avoid potential pitfalls. Furthermore, it embodies a mindset of prudence and financial responsibility that can benefit individuals in various aspects of their financial lives. So, next time, whenever you plan to buy a new car, make sure to implement the 20/4/10 rule to ensure a financially strong decision and set yourself up for long-term success.