How can the 20/4/10 budgeting rule help in your car buying decision?

Your car buying decision should not be influenced solely by your fascination with a specific car. Instead, you need to take a meticulous call so that you don’t go overboard and strain your finances unnecessarily. This is where the 20/4/10 budgeting rule for car buying comes into play. Let us explore this rule with an illustration for a better understanding.

1. 20% down payment: 20% in the rule refers to the ideal down payment you should make upfront i.e. 20% of the purchase price. The move will help reduce the total car loan amount, lower your monthly EMIs and consequently your long-term interest spendings.

2. 4 years tenure: ‘4’ in the rule specifies that you should target taking a car loan for a maximum tenure of 4 years. Shorter loan tenures, while resulting in a comparably higher monthly EMI amount, ensure that you pay off your car loan liability soon and reduce your total interest outgo significantly.

3. 10% of the gross monthly income set as cap: This part of the rule states that car buyers should limit all car-related expenses incurred month-on-month to maximum 10% of their gross monthly income. These expenses should account for EMIs paid on car loan, insurance, maintenance etc. The 10% cap ensures that payments made towards the car account align well with the allocated amount and do not bypass your budget.

Suppose Mr. X draws a monthly income of ₹1,50,000 and he is looking to buy a car with an on-road price of ₹9 lakh and the loan interest is 9% per annum. We apply the 20/4/10 rule to assess whether Mr. X should be making this purchase. Applying the 20/4/10 Rule

20% down payment: With the 20% down payment norm, he should be paying ₹1,80,000 upfront and take loan for the remaining ₹7,20,000

4 year loan term: EMI at the given rate of interest for a 48 month tenure will be ₹17,917 as the total interest comes to be ₹1.4 lakh.

10% monthly expense cap: For him, monthly outgo towards the car account should not be over ₹15,000 per month as per the rule. However, the EMI amount only exceeds this threshold.

So, summing up we can say that the current income does not go in favour of Mr. X purchasing this car if he goes by the 20/4/10 rule.

He can either look to save for a few more years or wait until his income increases significantly, or he can opt for a car priced at around ₹4.5 lakh; as according to the rule, it would mean:

Down payment of ₹90,000

EMI of ₹8.959

And considering other monthly car expenses of around ₹6,000, it can perfectly go with your budgeted expense of 10% of the total gross income i.e. ₹1.5 lakh in this case.

How apt is the 20/4/10 rule for car buying?

The rule can very well guide and serve as a reference point for first-time car buyers and those in the middle-income group.