It can be so tempting to buy a car you can’t afford. To make sure you get a car priced within your means, follow the 20/4/10 rule.
This car-buying rule is based on the size of your down payment, the length of your loan term and the percentage of your income that goes toward transportation costs. If you follow it, budgeting for a car becomes much easier.
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:
- 20% down payment: Aim to make a 20% down payment on your new car.
- 4-year repayment term: Choose a repayment term of four years or less on your auto loan
- 10% transportation costs: Spend less than 10% of your total 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.
Be aware that this car-buying rule works best as a general rule of thumb. You should adjust your strategy as needed, based on your own financial situation.
Additional car-buying considerations
- Determine what kind of car you need: Do you need trunk space and room for multiple passengers? Or are you focused on getting something easy to park with good gas mileage? Make a list of your wants and needs so you can more easily find the right car to buy.
- Set a budget: While the 20/4/10 rule for car buying can help you come up with an estimated budget, it doesn’t hurt to set a specific price limit for what you think you can afford to pay for a new car.
How does the 20/4/10 rule work?
While it may need 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 up front to decrease the amount you need to borrow when buying a car.
The 20/4/10 rule encourages you to put down at least 20% of the total price of your 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 make 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.
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 (48 months).
If you take out 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 probably pay more in interest.
By limiting the length of your loan term, you’ll avoid spending more on interest over time, and you’ll own your car sooner.
Keep transportation costs below 10%
The final piece of the 20/4/10 rule is the percentage of your gross income (monthly income before taxes) that you should spend on car-related expenses.
Between your auto loan, car insurance, fuel and repairs, owning a car can get expensive fast. In 2022, U.S. households spent an average of $12,295 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.
To estimate your payments, try using our auto loan calculator.
How to do a 20/4/10 rule calculation
Here’s a closer look at how this car-buying rule works in practice:
1. Calculate a 20% down payment
- Start by estimating the trade-in value of your current vehicle. You can use industry guides, like Kelley Blue Book or Edmunds, to give you a sense of how much your car is worth on the market.
- Subtract any amount that you owe on an auto loan right now.
- Add any amount that you’ve saved toward a down payment on a new vehicle.
- Multiply that number by 5.
- The answer will represent the total budget that you have to spend on a car if you want to be able to make a 20% down payment. Ideally, you shouldn’t spend more than this amount on your new vehicle.
2. Choose a 4-year (or less) loan term
- If you’re financing your new vehicle with an auto loan, do your best to choose a loan that has a repayment term of four years (48 months) or less.
3. Figure out 10% transportation costs
- Use your gross income for this calculation. It will give you the clearest picture of how much you have to spend.
- Divide that number by 10.
- Do your best to make sure your total transportation costs (auto loan, gas, insurance and repairs) aren’t more than this final number.
Example of the 20/4/10 rule
Now that you know how to do the calculations, let’s take a look at how this car-buying rule works in action.
1. Calculate a 20% down payment
Lucy paid off her current car a few years ago. According to industry guides, it has a trade-in value of $2,000. She’s also been saving up to buy a new car and has $500 to put toward a down payment.
Lucy’s down payment calculation would look something like this:$2,000 + $500 = $2,500 down payment$2,500 x 5 = $12,500 max car-buying budget
2. Choose a loan term of 4 years (or less)
After making her $2,500 down payment, Lucy needs to finance the remaining $10,000 of her new car. She chooses a 48-month loan at a 5% interest rate, for a total monthly auto loan payment of $230.29.
3. Figure out 10% transportation costs
Lucy brings home $4,200 a month, after taxes and deductions.
As a result, her transportation cost calculation would look like this:$4,200/10 = $420/month to spend on transportation costs
The 20/4/10 rule can give you financially sound guidance to budget for a car loan, but it’s not a hard and fast rule that will work for everyone.
| Pros | Cons |
|---|---|
Saves money: 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. Builds good financial habits: It can help teach you good financial habits, such as saving and budgeting for a large purchase. Has faster pay-off: A large down payment and short repayment term can help you pay off your car loan faster. | Doesn’t account for credit score: 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. Won’t consider inflation: Factors like inflation aren't taken into consideration, which can make buying a car much more difficult. Can’t make up for a small budget: 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. |
How to increase your buying power
Buying a car can take up a big chunk of your budget, and it takes financial discipline and patience. Here are a few tips and tricks you can use to make the process less expensive:
- Boost your credit score: Your credit score will be the single biggest factor in deciding the interest rate you get for an auto loan. If you have bad credit, work to improve your score before applying so that you can snag a more affordable rate.
- Buy a used car instead of a new one. While new cars tend to have better financing options, buying a used car tends to be cheaper. With a used car, you could have a much smaller 20% down payment.
- Save up for a larger down payment. Providing a down payment that’s more than 20% will lower your minimum monthly car loan payments and may make it easier to keep your transportation costs under 10%.
- Stick to a base model. While upgraded car models come with plenty of bells and whistles, a base model will cost you less and make it easier to afford up front.
- Compare loan offers. Receiving multiple auto loan offers is important because it lets you compare rates from different lenders. This can help you find the best deal and save money on interest in the long run.
- Shop around for car insurance: Expensive car insurance can add to your overall transportation costs. Be sure to compare car insurance quotes from different lenders so that you can land on a policy that works for you and your wallet.
View Personalized Offers
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 such cases, it might 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. But if you want to use cash to buy a car, you might have to choose a cheaper used car rather than a new one. In January 2024, the average price of a new car was $47,401, according to Kelley Blue Book.
Auto loan pre approval is a firm offer from a lender that helps you figure out how much a new or used car will cost you. You can compare multiple preapprovals from car loan lenders to find the offer that works best for you.
