For many people, cars are an essential part of life. They provide transportation to work, school, and nearly every other place you can think of. However, buying a car comes with major expenses. How much can you afford? We will talk about how to budget for a car purchase with the 20/4/10 rule.
[ READ MORE: How Your Car Loan Affects What You Pay ]
What is the 20/4/10 Rule?
A general rule for buying a car is the 20/4/10 rule. The 20 means that the car you buy should have at least a 20% down payment. The 4 means you should go no more than a four-year loan to pay back your vehicle. Finally, the 10 means you should be paying no more than 10% of your annual gross income on car payments.
Here’s a test calculation. If you make $50,000 a year in gross income, then you can comfortably afford a vehicle worth up to $5,000. By taking 20 percent of this number, your first down payment should be $1,000. Now, let’s say you got a car loan of $4,000. With 48 months to pay, you should expect to pay $83.33 a month plus the interest that accrues over the four-year period.
Understand Your Spending
The 20/4/10 rule is a conservative way to safely make payments without going into the red. However, what are your spending habits like? If you are a heavy spender and don’t have much in savings, you’re at greater risk of missing payments than someone who’s great with saving. Missing payments will also create more financial burden with late charges and credit score decreases.
To understand if you can handle the purchase, try paying yourself. If you are expecting to buy that $5,000 car, set aside the down payment and the monthly payments each month. After a few months, ask yourself these questions. How much money do I have leftover, not counting the “car payments” I made? Am I comfortable to make these payments each month for the next four years? Everyone’s financial situations are different, so understand yourself before you make the commitment.
Ready to apply for financing? Fill out our online form and we will help you understand your budget. If you have questions on any of our vehicles, contact us on our website and we will get back to you.