What Is the 20/4/10 Rule? A Smart Car Buying Strategy Explained

DuxX / Getty Images/iStockphoto

Commitment to Our Readers

GOBankingRates' editorial team is committed to bringing you unbiased reviews and information. We use data-driven methodologies to evaluate financial products and services - our reviews and ratings are not influenced by advertisers. You can read more about our editorial guidelines and our products and services review methodology.

20 Years
Helping You Live Richer

Reviewed
by Experts

Trusted by
Millions of Readers

You’d love to purchase a new car, but need to make sure you can afford it. The 20/4/10 rule may be the budgeting hack you’re looking for. To follow this rule, you need to make a 20% down payment on a four-year or less auto loan. In addition, you should spend 10% or less on your monthly car expenses. 

Use this rule of thumb when buying a car, and you will likely still stay within your budget and maintain your financial goals. Find out more about the 20/4/10 rule and how it works. 

How the 20/4/10 Rule Works

The 20/4/10 rule is one way to establish a car budget. Here’s how the different parts work.

20% Down Payment

Pay down at least 20% of your car’s target total purchase price. This will help lower your total loan payment amount and avoid the risk of owing more than the car is worth.

For example, if you want to buy a car for $30,000, a 20% down payment is $6,000.

4-Year Loan Term 

Keep your loan terms to 48 months or less. Using this approach keeps the loan term short and encourages budgeting and long-term planning. 

10% Gross Monthly Income

Calculate your total monthly car expenses. This may include your loan payment, gas, insurance and maintenance.

The full amount should be no more than 10% of your gross monthly income. This method helps encourage you to choose a car that fits your finances.

Here’s an example:

How To Apply the 20/4/10 Rule to Your Car Purchase

Ready to put the 20/4/10 rule into action? Follow these five steps to apply it to your next car purchase.

Step 1. Calculate 10% of Your Gross Monthly Income

Knowing your monthly car-related budget will help you manage your finances accordingly. For example, if your gross monthly income is $7,000, your budget for car-related expenses is $700 ($7,000 x 0.10).

The $700 amount must cover the following expenses:

• Car payment
• Insurance
• Gas
• Maintenance or repairs
• Registration fees

Step 2. Determine Your Available Monthly Loan Amount

Estimate the amount of money for gas, insurance and maintenance costs. Use this total number and deduct it from the 10% monthly budget for car-related expenses.

Here’s a breakdown:

• Ten percent of income: $700 budget
• Estimated other costs like gas, insurance and maintenance: $200
• Amount left for car loan: $500

Step 3. Choose a Loan Term of Four Years or Less

Keep your car loan length to 48 months or less to avoid long-term debt and lessen interest payments. 

Step 4: Find Out What You Can Afford for a Down Payment

You need to assess your savings available for buying your car. Ideally, you should calculate 20% of your target price.

Here’s an example: Your target car price is $25,000. Plan for a down payment of $5,000.

Review your finances and determine if you have an adequate cushion to afford the down payment and still have enough savings available.

Step 5. Use a Calculator To Check What You Can Afford

Calculators can help you figure out how much car your car should be. You can plug in your loan amount, interest rate and term to verify your monthly payment amount.

For example, imagine you need to finance $20,000 for your car loan. If your interest rate is 6%, your monthly payment amount over 48 months is $470. This falls within your budgeted cap of $500. 

Pros and Cons of the 20/4/10 Rule 

Is this rule right for you? Here’s a look at the pros and cons.

Pros 

• Helps to keep you within budget: The use of the 20/4/10 rule enables you stay financially disciplined with a car budget. 
• Limited interest payments: A shorter loan means that less of your income is going toward interest payments.
• Creditworthiness can improve: You can limit your debt-to-income ratio with the 20/4/10 rule. 

Cons 

• May limit selections: Staying under 10% of income limits purchases to smaller or older vehicles. 
• Low-income earners may struggle: Those whose earnings are lower may struggle to save 20%. 
• Assumes that income will be stable: Freelance workers or those with irregular earnings may find the 10% cap too difficult to meet. 

Tips for Staying Within the 20/4/10 Guidelines

Staying on track with the 20/4/10 guidelines may be easier than you think. Here are some tips: 

Keep a Firm Budget

Have a good idea of your budget before shopping for your car. Knowing your debt limits will make it easier to find the right car without overstepping your financial means. 

Buy Used Instead of New

Look for a used car vs. new car. A used car that is two or three years old may offer a better value and help you avoid sharp depreciation. 

Shop Around for Interest Rates

To secure the best interest rate, do your research. Comparison shop among multiple banks, and if you belong to a credit union, utilize that option as well.

Avoid Adding Upgrades

The dealer will try to sell you various warranties, protection packages and dealer-installed extras. These “upgrades” will increase the cost of your car. 

Consider Preapproved Loans

When you walk into a dealership with a preapproved loan, you have more negotiating power and are more likely to stay within your budget. 

Additional Car Buying Rules To Know

There are other strategies for car buying that you may want to consider. Here are some other options: 

• Buy a car with cash: You can avoid interest entirely if you buy a car with money you’ve saved. 
• Opt to buy a used car: Buy a car that is two to four years old to forgo sharp depreciation and still take advantage of modern features. 
• Use the 15% take-home rule: Do not spend more than 15% of your net pay on total car expenses, including financing, insurance, gas and maintenance. 
• Employ the 10% rule: Try to limit your monthly car payment to 10% of your gross monthly income. 

Conclusion: Making Informed Car Buying Decisions 

Using the 20/4/10 rule will help you find a car that fits within your budget. This car payment rule can help you keep shorter loan terms, pay less interest and maintain your other financial goals.

Share This Article: