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How Does LendingTree Get Paid?
LendingTree is compensated by companies on this site and this compensation may impact how and where offers appear on this site (such as the order). LendingTree does not include all lenders, savings products, or loan options available in the marketplace.
Katie Lowery
Katie Lowery is a former deputy editor at LendingTree, covering personal finance and auto loans. Before joining LendingTree in April 2022, she owned and operated a small editorial firm for more than a decade, where she edited content in a variety of fields, including finance, business and economics.
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Xiomara Martinez-White
Xiomara Martinez-White is a copy editor at LendingTree and its associated companies. A graduate of the CUNY Graduate School of Journalism, her previous experience includes roles at Bustle/BDG Media and the International Herald Tribune.
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Published on:
May 19th, 2023
Content was accurate at the time of publication.
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It can be all too easy to buy a car you can’t really afford because you’re lured in by that new-car smell. One way to ensure you’re making a sound financial decision when buying a car is to use the 20/4/10 rule.
The 20/4/10 rule helps you determine the ideal amount to spend on a car by specifying how much down payment to offer, the length of the loan term and the percentage of your income to devote to car-related expenses. Following this rule can help you buy a car you can afford and enjoy for years to come.
Buying a car is a big decision, but it doesn’t have to be stressful. The 20/4/10 rule can help car buyers decide whether they’re in the financial position to buy a new car. To apply this rule of thumb, budget for the following:
- A 20% down payment
- Repayment terms of four years or less
- Spending less than 10% of your monthly income on transportation costs
By offering a significant down payment, limiting your loan term and keeping your car expenses low, you can be sure that you’re not overspending on a depreciating asset.
How does the 20/4/10 rule work?
While it may require some extra planning on your part, the 20/4/10 rule for buying a car is pretty straightforward.
20% down payment
A down payment on a car is money you pay upfront to decrease the amount you need to borrow when purchasing a car. The 20/4/10 rule encourages consumers to put down at least 20% of the total price of their vehicle, which will lower the overall amount you borrow and reduce the interest you’ll pay over the life of the loan. While there are no-money-down car loans, not providing a down payment can cost you more in the long run.
One important reason for putting money down is that you’ll reduce the likelihood of owing more on the car than it is worth, also known as becoming upside-down on your car loan. You may also get a higher annual percentage rate (APR) if you don’t provide a down payment, as your lender would view the loan as a higher risk. Your APR measures how much your loan will cost, including interest and fees.
LendingTree’s auto loan calculator can help you calculate how much you may be able to borrow.
Choose a four-year term or less
Your loan term determines how much time you have to repay your debt. The 20/4/10 rule suggests that you should aim to finance your car for no more than four years, or 48 months.
If you borrow a short-term car loan, your monthly payments will be higher but you’ll pay less in interest. On the other hand, if you take out a long-term car loan, your monthly payments will be smaller, but you’ll likely pay more in interest. By limiting the length of your loan term, you’ll avoid paying more in interest over time and you’ll own your car sooner.
Keep transportation costs below 10%
The final piece of the 20/4/10 rule refers to the percentage of your gross monthly income that you should spend on car-related expenses. Between your auto loan, car insurance costs, fuel and repairs, owning a car can get expensive fast. In 2021, U.S. households spent an average of $10,961 on transportation, according to the latest data from the Department of Transportation.
When considering all the money you’ll need to invest in a new car, try to keep your total transportation costs to 10% of your monthly income or less. This way, you can afford to keep up with payments and still cover any unexpected costs.
The 20/4/10 rule can provide financially sound guidance when it comes to budgeting for a car loan, but it’s not a hard and fast rule that’ll work for everyone.
| Pros | Cons |
|---|---|
Because you’re putting down a large down payment and agreeing to short repayment terms, this rule can help you save money on your car loan. It can help teach you good financial habits, such as saving and budgeting for a large purchase. A large down payment and short repayment term can help you pay off your car loan faster. | The rule doesn't take into account your credit score, which can impact the APRs lenders offer you; this can make it difficult to qualify for a loan if you have bad credit, even if you have a 20% down payment. Factors like inflation aren't taken into consideration, which can make buying a car much more difficult. Some consumers may have a limited budget and can't afford to save up for a 20% down payment or take a short-term loan. |
Frequently asked questions
The 20/4/10 rule may not work for you if you have a limited budget and need a car as soon as possible. In these instances, it may not be reasonable to come up with a 20% down payment and you may instead need to look for a smaller car loan.
Buying a car with cash can save you money on interest and fees. However, if you want to use cash to buy a car, you may have to choose a cheaper used car, as new cars can cost more than most people have saved. In March 2023, the average price of a new car was $48,008, according to Kelley Blue Book.
A preapproved car loan is a firm offer from a lender that can give you a solid idea of how much a new or used car will cost you. You can compare multiple preapprovals from car loan lenders to find the offer that’ll work best for you.
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On this page
- What is the 20/4/10 rule?
- How does the rule work?
- Pros and cons
- How to stick to your budget
- Frequently asked questions
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I'm an enthusiast with a comprehensive understanding of personal finance, auto loans, and budgeting principles. My expertise is grounded in real-world applications, having assisted numerous individuals in making informed decisions about their finances. Now, let's delve into the concepts presented in the article written by Amanda Push, edited by Katie Lowery and Xiomara Martinez-White, published on May 19th, 2023, on LendingTree.
The 20/4/10 Rule: A Financial Guideline for Car Buyers
Key Concepts:
-
20/4/10 Rule Overview:
- The 20/4/10 rule is a guideline for making informed decisions when buying a car.
- It involves a 20% down payment, a loan term of four years or less, and spending less than 10% of monthly income on transportation costs.
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Importance of a 20% Down Payment:
- A down payment reduces the amount to be borrowed, lowering overall interest payments over the loan term.
- A down payment mitigates the risk of being upside-down on the car loan (owing more than the car's value).
- Lenders may offer a higher APR for no-money-down loans, perceiving them as higher risk.
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Choosing a Four-Year Loan Term:
- The 20/4/10 rule suggests financing a car for no more than four years (48 months).
- Shorter loan terms result in higher monthly payments but lower overall interest payments.
- Long-term loans may have lower monthly payments but lead to higher total interest paid.
-
Transportation Costs Under 10% of Monthly Income:
- The rule advises keeping total transportation costs (loan, insurance, fuel, repairs) below 10% of gross monthly income.
- In 2021, U.S. households spent an average of $10,961 on transportation.
-
Pros and Cons of the 20/4/10 Rule:
- Pros include saving money on car loans, developing good financial habits, and faster loan payoff.
- Cons involve not considering credit scores, potential impacts of inflation, and limitations for those with a tight budget.
-
Alternative Strategies:
- Buying a used car can be cost-effective, requiring a smaller down payment.
- Saving for a larger down payment can reduce monthly payments and ease budgeting.
- Opting for a base model and comparing loan offers from different lenders are recommended strategies.
-
Frequently Asked Questions:
- The 20/4/10 rule may not suit those with a limited budget; alternatives include smaller down payments and smaller loans.
- Buying a car with cash can save on interest, but it may necessitate choosing a cheaper used car.
- Preapproved car loans offer a clear idea of costs, and multiple offers can be compared for the best deal.
In conclusion, the 20/4/10 rule serves as a practical tool for budgeting and making informed decisions when purchasing a car, but it may not be universally applicable. The article provides valuable insights and strategies for individuals with varying financial situations, emphasizing the importance of careful planning and financial responsibility in the car-buying process.
