Tuesday, 5 November 2019

How Much Car Can I Afford | 20/4/10 Budget Rule

20/4/10 Budget Rule

Today we're talking about 20/4/10 rule, and how it applies to buy a car. If you can't afford to buy a car with cash, how do you finance a car or what's the best way to finance a car?

20/4/10 - What Do These Numbers Mean or Represent.

20% Minimum Down payment Amount

20 is your down payment, 20% should go towards the down payment of the car. If the car is $20,000, $4,000 should be what you have as a down payment. If you don't have $4,000, you know you need to decrease the price of the car.

4-Year Max Loan (48 Month)

The 4, is your maximum term. This is the maximum loan amount in a year, the 4 is talking about your loan should not more than 4 years. (48 months)

10% Of Total Monthly Income To Car

10 means, 10% of your total monthly income should go towards the cost of this car including maintenance and gas and all the good stuff that comes with owning a car. You're trying to keep it to 10% of your total monthly income, encompassing everything that involves this vehicle.

Let's take a look at a real-life example of how this would apply to john, the car buyer.

John the car buyer is someone who makes $60,000 a year, you divide that by 12, which gets you $5,000 a month.
  • $60,000 divide by 12 = $5,000 a month

Obviously, if you take 10% of that, going back to our 10% rule, you know that John is going to be working with a budget of $500 a month

Let's go through a real-life scenario where John is looking at a vehicle that cost $25,000. We're going for apples to apple comparison.

Scenario 1

  • Car cost: $20,000
  • Down Payment: $0
  • Interest Rate: 4.7%
  • Term: 60 months
  • Monthly Payment: $468
  • Interest on Loan: $3,100

John is going to be putting down $0 for his down payment. I went on bank rate and I looked at used-car rates, and they're averaging about 4.7%. He's going to finance this vehicle and break the rule, and he's going to finance it for 60 months. His payment is going to be $468 a month, and then the interest that he's paying over the course of this 60 month is going to be $3,100.

Scenario 2

  • Car Cost: $20,000
  • Down Payment: $5,000
  • Interest Rate: 4.7%
  • Term: 48 Months
  • Monthly Payment: $458
  • Interest On Loan: $1,978

You know that the car is $25,000, however, in this case, John is actually going to be putting $5,000 down. He's financing $20,000, he's putting down $5,000 down payment, the comparison rate is going to be the same, 4.7%, however, he's actually going to follow the 4, in the 20/4/10 rule.

He's going to be at 48 months, and then finally, his payment is going to be lower, believe it or not, at $458 a month, the total amount of interest that he paid over the course of these 48 months is going to be $1,978.

The first 2 things that I notice is that his payment is actually $10 a month less than the person that put no money down.

Secondly, this person in the second scenario is actually shaving a year off of this term. Not only did he drop the payment by putting down $5,000, but he also dropped his loan by 12 months.

This brings me to my next point, he can start saving the $458 a month, while still owning the car outright. This is going to create a hybrid from my last article. If you take $458 a month time 12, that's the year that he has no car payment, that actually comes out to be $5,496.

  • $458 X 12 = $5,496

I want to take this scenario of him using $5,000 and let's turn this into a hybrid article.

Read: How Cars Keep You Broke

How To Buy a Car Using Cash

If John the car buyer takes that $5,000 and buys a car with cash, you know that he's still saving that $458 a month. 

In year 2, after saving this $458 a month diligently, he's going to have roughly $11,000 in the bank. 
  • Year 2: $11,000
  • Year: 3: $16,500
  • Year 4: $22,000

All he did was wait 4 years, take the payment he would have been paying, and in 4 years he can buy a $22,000 car with cash if he wanted to.

Do you see how powerful it is to just delay a little bit of gratification, yes, there's going to be maintenance expenses that go along with this, so it's not going to be exactly $458 a month? However, in 4 years he's driving a pretty nice car in my opinion.


Either way, whether you want to use the 20/4/10 rule, or whether you want to buy a car with cash, just save up the rest of what would have been your payment, you can see that this is a good way of buying a car or financing a car if you absolutely have to.

I hope you got value out of this article 

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