If you’re in the market for a new car, chances are you’re looking for what you want rather than doing what’s best for your wallet. Of course, you should also keep in mind your financial situation as you shop for a new car.
There’s a nifty rule called the 20/4/10 rule that I just discovered. I wish I knew this 13 years ago, when I bought my first car as I paid for too much car back then. This was when I first started out in my career as a young engineer, making just $41,000 a year.
I just bought another car in September of 2018, and this time I didn’t know it but I followed (kinda) the 20/4/10 rule!
The 20/4/10 rule for car buying is really quite simple. You take the total price of the car and break it down like this:
- Make a 20% down payment.
- The loan term should be no more than 4 years.
- The monthly car payment, including insurance, shall fall below 10% of your gross monthly income.
When you crunch the math here, resist the temptation to put down more than 20%, even if you have the money, so as to lower the monthly car payments. This fudges the numbers. The objective right now is to figure out how much car you can afford. You can always put down more for your down payment when you actually walk into the dealership.
Let’s take an example. Suppose your yearly salary is $100,000. That means your monthly gross salary is $7692.31. Take $100,000 and divide by 26 pay periods in a year, then multiply by 2 for the monthly gross income. Let’s also assume your monthly insurance premium is $100. Of course, the more expensive the car the higher your premium will be. But for this example, let’s just say your monthly insurance premium is $100.
That means your monthly car payment, after insurance, should be less than $769. Subtract insurance and it’s $669.
But you’re probably more interested in how much car you can actually afford. So, I’ve tabulated the results in the table here for you:
| Salary | Monthly Payments (just the car) | Total Monthly Payments (including insurance) | Total Interest Paid | Total price of car you can afford |
| $30,000 | $130.77 | $230.77 | $308.36 | $7460.76 |
| $40,000 | $207.69 | $307.69 | $489.73 | $11849.24 |
| $50,000 | $284.62 | $384.62 | $671.13 | $16238.28 |
| $60,000 | $361.54 | $461.54 | $852.51 | $20626.76 |
| $70,000 | $438.46 | $538.46 | $1033.89 | $25,015.24 |
| $80,000 | $515.38 | $615.38 | $1215.26 | $29403.72 |
| $90,000 | $592.31 | $692.31 | $1396.66 | $33792.77 |
| $100,000 | $669.23 | $769.23 | $1578.04 | $38181.25 |
| $110,000 | $764.15 | $864.15 | $1801.86 | $43,596.67 |
| $120,000 | $823.08 | $923.08 | $1904.82 | $46958.78 |
| $130,000 | $900 | $1000 | $2122.20 | $51347.26 |
| $140,000 | $976.92 | $1076.92 | $2303.57 | $55,735.73 |
| $150,000 | $1053.85 | $1153.85 | $2484.95 | $60,124.21 |
Assumptions:
- Based on an APR of 2.49% at 4 years.
- Numbers are in USD.
So if you make $100,000 the most car you should get is $38,181.25. If you want to crunch the numbers yourself with Excel, the loan amortization function you’ll want to use to figure out the monthly payment is PMT.
Your car will constitute as one of the highest expenses in your household. The 24/4/10 rule is a way of making sure you put a limit on this spending. Of course, there are other ways to save money.
Buy Used
That’s what I did when I bought my most recent car. I bought a certified, preowned vehicle. Right off the bat, I saved $20,000. This was after two years’ depreciation. A car’s value will drop the most its first year. In the second, third, and four years, it will typically drop in value equal to that of the first year’s deprecation. So, the lesson here is to buy used.
If you don’t like the idea of buying a used vehicle from a private party, then opt for certified preowned. Dealers have to follow a multi-point inspection in order to qualify their used cars for resale. Most of these are cars that were leased. Better yet, if the car is relatively young it will still include the original manufacturer’s warranty from the original date (not when you bought the car).
Of course, if you’re handy or know a mechanic who can fix your car on the cheap, that’s the best way to go. Then you can forgo any warranty and extended warranty offers the dealer is bound to throw your way when going through the finance phase of the car-buying process.
Pay It Off Quickly?
I’m a big fan of being able to pay off a car loan ahead of time and will always ask if there are any pre-payment penalties. At the same time, I put down more than the suggested 20% (actually, around 48%!) so my monthly car payment is quite low at $358.
I should also add that at the time I bought the car, I didn’t know about the 20/4/10 rule. So, I actually have a 5-year loan. Whatever approach you take will be up to you and your financial situation. The 20/4/10 rule is a good rule to apply because a car represents one of the highest expenses in your household.
A car is not an asset, but a liability. An asset gains value over time but the liability that is your car costs you money (maintenance and repairs, gas, insurance). Some people look at their cars as tools. So, they buy the cheapest car they can get. And that’s not a bad idea because most modern cars are reliable and rarely break down.
Other people, like me, might decide to treat themselves to something good, especially having driven their last car for the past 13 years. That’s what I did. My air conditioner died. My right turn signal stopped resetting after a turn many years ago. My control arms were going out. The engine was burning oil. My car had reached the point where it was cheaper to buy a new one than to try to fix everything that was broken.
No, don’t get me wrong. I babied the car and took real good care of it. In fact, some of my friends were surprised to find out it was over ten years old and commented it looked almost new.
But we have to say goodbye to our cars ultimately from wear-and-tear.
I got myself a BMW 5-series because…
- I no longer wanted to feel the oscillations in the road, which I would, sitting in a restaurant after a 5+ hour drive in my Mazda 3.
- The BMW dampens the bumpiness of the road quite well.
- I likely had some hearing damage, too, because that same restaurant would sound muffled. I was still hearing the road noise. It took many hours for the muffledness to dissipate.
- The BMW is one of the most comfortable cars I have driven. It is super-quiet inside the cabin.
- The lack of a heads-up unit made it dangerous for navigation, too. I would take my eyes off the road from time to time as I navigated in traffic.
- The BMW has a turn-by-turn instructions built right into the windshield.
- The car had low NHTSA safety ratings.
- The BMW has a high safety rating.
In truth, I have some negative energy blocks when it comes to money. For one thing, I didn’t think I deserved something nice. For another, I thought it was an utter waste of money to get a car like a BMW. What was really going on was I didn’t respect and like myself enough to treat myself well. Self-esteem issues pop up and manifest themselves in the unlikely of places.
So, you can see why in come cases it’s justifiable to get yourself something nice. After all, you’re making money, saving, and investing so that you can enjoy the finer things in life. Cheapness for the sake of being cheap is just pathetic. There will be other financial gurus in the money space who will try to get you to pinch every penny and save the maximum, saying that’s how they achieved early retirement.
You’ll have to decide what’s the right lifestyle for you.
Pay It Off Quicker and Drop Comprehensive
There’s another reason to pay off your car quickly. The bank requires you to get comprehensive and collision insurance coverage in order to protect their investment. This equates to a higher premium per month.
As soon as your car is paid off, drop the comprehensive and collision part of your insurance. Your monthly premium will drop, too. On mine, if I have drop both comprehensive and collision, then the premium is about 2.5 times less ($44 versus $115 for six months). For the life of the loan, I’m basically paying $4260 more.
Imagine putting this extra money to work for a few years…
But like anything else, it depends…I opted for a five-year loan as a middle-ground solution. While I do have the money to pay for the car outright, there’s always an opportunity cost in doing anything. In this case, it’s lost opportunity in investments I could have made but missed out on because I didn’t have the money. So, I decided to have the money in hand to jump on opportunities when they appear. And I’m willing to pay the $5560 in interest and insurance premiums.
In other words, I gamble that the return on my investments would likely exceed the interest and premiums I pay. At the same time, I already have a plan in place to pay a little more each month so as to pay off the car loan in 4 years.
Plan Ahead for the Next Car Purchase
Even though I just bought a new car, I am already planning for the next car. I don’t know what I’m going to get yet, as it’s too far away. But what I am doing is saving money for a down payment now. That way, you can avoid paying a lot in interest for the life of the loan of that next car.
Of course, a German car isn’t actually known for its reliability. They are notorious across the board (Audis and Mercedes) for coolant and oil leaks. The most “problem” I found with a Lexus (really a Toyota) is a buggy software in their head unit. Other than that, Japanese cars typically cost 2 to 3 times less to own and maintain that their German counterparts.
But that brings me to my next point: When you are old and look back at your car history, will you thank yourself and say that you did the practical thing? Or would you say that you got the car you wanted and so you have no regrets? Because regrets are one of the biggest laments of the dying. Take a chance and go after what you want (within financial reason of course) rather than what’s practical!
In Closing
At the end of the day, ask yourself a question: What is the purpose of money? Why am I saving? I am a strong believer that money is an amplifier of the good we can do in this world. It is our faithful servant and enables us to live comfortably. The more money we have, the more comfortable we are able to live.
You are saving because you want to live a good life, filled with comfort and joy. So, keep these things in mind when shopping for your next car.