Buying a Car with the 20/4/10 Rule
- Xa Hopkins
- Sep 9
- 6 min read
Buying a car is a large financial decision, sometimes made out of necessity when moving to a car-dependent area and sometimes made to add ease and luxury to your lifestyle! Either way, you want to make a prudent financial decision for your current personal finances by making sure a car purchase does not trigger financial strain.
The 20/4/10 Rule is commonly used to help you determine whether purchasing a vehicle is within your financial means. In this rule, each number stands for:
20: You should put down at least 20% of the price of the car as a downpayment.
4: Any loan you assume should be paid in full within four years.
10: At most, 10% of your monthly budget should be allocated towards transportation expenses.
The 20/4/10 Rule prevents most car purchase disasters, but you should think beyond these parameters when purchasing a car to make sure you are making a purchase you value.
Do You Even Need a Car?
Before jumping into the financial details of the 20/4/10, make sure you need a car! We lived without a car in Washington, DC for five and a half years and loved it. Most people know you can get around DC without a car, but bus systems in significantly smaller cities also make it possible to get by with public transportation and the occasional rideshare. If you are still unsure whether a car is a good decision for your lifestyle, check out our article about how to consider housing and transportation costs together when parsing out your “needs” costs!
How Much Do You Value a Car?
Particularly if your answer was “no” to needing a car, determine how much you value having a car. We do not need a car, but we have one because it adds value to our lives. However, the amount we value a car was not enough to push us to buy a car when we initially moved to DC. We slowly saved and eventually bought a car in cash when the price of cars dipped as rental car companies sold off their inventory during 2020. The price dip met the amount we were willing to spend from our high-yield savings accounts, so we went ahead and made the purchase!
In situations where a car is a luxury item rather than a necessity, especially if it is clearly a luxury item thanks to reliable public transportation in your area, you should alter the 20/4/10 rule to better reflect how much you value car ownership. Below, I suggest how you may alter the ratio to better reflect your values.
The 20% Downpayment
A downpayment between 10-20% is usually required when purchasing a car. Used cars often only require a 10% downpayment because they do not depreciate in value as rapidly as new cars after purchase. New cars will almost always require a 20% downpayment to cover the expected depreciation that occurs upon driving a car off the lot. However, paying a 20% downpayment on the car is a smart rule to follow whether you opt to purchase a used or new car.
This is partially because the act of saving that initial downpayment indicates that you should be able to afford the car on an ongoing basis. If you save a downpayment of 20% over the course of a year, paying off the car loan in four years (20% each year) should be within your means. For example:
Year before buying a car: Save 20% of car value
Buy a car with 20% down
First year with car: Pay 20% of value over year*
Second year with car: Pay 20% of value over year*
Third year with car: Pay 20% of value over year*
Fourth year with car: Pay 20% of value over year, paying off the car loan*
*This is a simplified calculation since the actual payment will include interest.
In addition to the act of making sure you can afford the car payments, a 20% downpayment protects you from owing more than the value of the car based on typical depreciation. Cars are not usually like houses—while houses appreciate over time, cars depreciate. (There are exceptions to this. We could have sold our car at a profit a year after we bought it because car prices rose dramatically as people became vaccinated in time for summer and decided road trips were the perfect option to ease back into travel.)
If you are someone who is buying a car as a luxury item, the downpayment is an ideal area to manipulate. If you put a lesser value on a car, you may want to save over a longer timeline, pay a larger downpayment, and enjoy a lower monthly cost that better represents how much you value having a car.
Pay the Loan Within Four Years
The average car loan is now longer than five years, but that does not mean you should choose a long loan term. You have two options for loan repayment to make sure you pay off your car loan quickly:
Opt for a four-year loan term.
Choose a five-year loan term, but pay more than the required monthly payment to pay down the loan in four years instead of five.
The first option is simple. The second option requires more nuance. If you secure a five-year loan planning to pay more than the required monthly payment, you must verify that your additional contributions each month pay down the principal rather than interest. This will decrease the overall amount of money you need to pay on the loan, assuming you pay the loan off early.
Someone may decide to take out a five-year loan and pay over four because this offers financial flexibility if a financial emergency occurs. While the intent is to pay off the car in four years, you can scale back on loan payments if you lose your job or have a medical emergency. That said, you should only pick a five-year loan term if you have the financial discipline and attention to details to make sure you are making higher payments towards the principal.
Transportation Costs Should Be 10% or Less of Your Budget
Up front, this historically meant 10% of your gross income, but I would recommend using 10% of your net income for a more frugal approach that withstands various tax situations and realistically considers the rising cost of living. Especially if your car is a luxury item, stick to 10% of your net income.
Notice that this does not say your car payment should be 10% of your budget. Transportation costs should be 10% of your budget. This means your car payment, car insurance, gas prices, parking costs, and regular car maintenance should all add up to an amount that is 10% or less of your budget. If you still plan to get a couple Uber rides or take the bus here and there, those costs are included as well. All costs associated with your car and transportation should combine to less than 10% of your budget.
Currently perplexed while looking at your budget and trying to figure out how the average monthly payment of $745/month for a new car fits into your budget? It probably does not. You have to make these decisions for yourself based on your own values. The average monthly payment for a 2021 Honda Civic is around $380/month, and that sounds a lot better to me. You may find that this budget parameter guides you to a used car, smaller vehicle, or less luxurious brand.
Why Use the 20/4/10 Rule
Impacting your purchasing decision is the point. The 20/4/10 rule shows you how to buy a car responsibly so you do not end up with debt you cannot afford to service. We bought a 2017 Honda Civic in 2020, and it gets us from Point A to Point B as well as any luxury car.
For those purchasing a car as a luxury good rather than a necessity, you may have different calculations here that span the spectrum of costs. Some of you may be like us and want to keep transportation expenses below 5% of your net budget. Others may save for a longer period of time to buy the true luxury item, i.e., save for years and then get the convertible or sports car. If your car is a luxury item, go as luxury as you want, as long as it falls within your budget! I would suggest saving for longer rather than taking on a large monthly payment in this situation, but you can still use “10% of your budget” as a benchmark even if you need to save a larger downpayment for the math to work on a luxury vehicle purchase.
You can buy a car if you need a car. You can buy a car if you want a car. But only buy a car you can afford.
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