20/4/10 Rule of Thumb for Car Buying

Use this rule to determine the right car budget for you

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Joyce Chan / The Balance

Buying a car is a major financial commitment and often one of the biggest purchases many people will make in their lives. Figuring out the best way to fit a car purchase into your budget is key to making sure you buy an affordable set of wheels. The 20/4/10 rule of thumb for car buying is one way to quickly narrow down your vehicle options when you’re preparing to finance a new car.

Here’s how the rule works so you can figure out how to apply it to your own finances, plus some insight on when it might make sense to bend the rules to fit your circumstances.

Key Takeaways

  • The 20/4/10 rule of thumb for car buying helps you shop for a vehicle that will fit your budget.
  • The rule is to make a 20% down payment on a four-year car loan and spend no more than 10% of your monthly income on transportation expenses.
  • Because your credit score affects the size of your monthly payment, you may need to buy less car if you have a lower credit score.
  • Some car buyers may need to adjust the numbers slightly to better fit their budgets.

How Does the 20/4/10 Rule of Thumb for Car Buying Work?

The 20/4/10 rule uses straightforward math to help car shoppers figure out their budget. According to the formula, you should make a 20% down payment on a car with a four-year car loan and then spend no more than 10% of your monthly income on transportation expenses. That 10% spent on monthly transportation includes your auto loan payment, maintenance, gas, and car insurance.

For instance, under the 20/4/10 rule, a person making the U.S. median annual income of $68,703 should aim to spend less than $573 per month on transportation costs.

You can decide whether to use gross or net income to calculate the 10% amount. Using your gross income allows you to spend more on your vehicle, while using your net income provides a more conservative number.

When you calculate 10% of your own monthly income, you can then use your budget to figure out whether you can afford that monthly payment. For example, if your annual income is $68,703, your monthly budget should show you whether you have a surplus of $573 to dedicate to an auto loan payment, plus other transportation expenses.

Why the 20/4/10 Rule of Thumb Generally Works

For most people, the 20/4/10 rule is a simple enough guide to stick to for car shopping. Understanding your budget in advance gives you more negotiating power when you're shopping around.

Using our example from earlier, someone who makes $68,703 a year and sets aside 10% of their monthly income—$573—for transportation costs could aim to use no more than 20% of that for auto insurance, maintenance, and gas. That would then leave $458.40 for a car loan payment. 

As auto loan interest rates—and therefore, your monthly payment—hinge on your credit score, they also impact your car loan amount. For example, a car buyer with a very good or excellent credit score of 720 to over 800, could qualify for a low 4.18% annual percentage rate (APR), according to FICO. On the other end of the spectrum, a car buyer with a low credit score, between 500 and 589, may qualify for a 16.71% APR.

Here's how credit scores translate to your car-buying decision. Sticking to a monthly car payment of no more than $458.40 means a person with an excellent credit score could borrow $20,000 and manage a total vehicle purchase price of $25,000 (including the 20% down payment). On the other hand, buying with a low credit score could limit you to a loan of $17,600 and a total vehicle price of $22,000.

Furthermore, the car buyer with the low credit score could ultimately pay over $4,000 in interest on a four-year loan, while the buyer with the excellent credit score could pay less than $1,500 in interest over the same term on a more expensive vehicle.

You can use a car loan calculator to plug in your own numbers including your credit score to determine your potential interest rate and monthly car loan payment.

Grain of Salt

The 20/4/10 rule of thumb doesn't work for all car-buying situations. While the rule does allow you to spend up to 10% of your monthly income on transportation costs, your other monthly expenses may not allow you to spend quite that much. In addition, you may be able to spread your payments over five or six years instead of four to lower your monthly payment.

Be careful extending your car loan beyond four years, especially if you have a bad credit score. Your monthly payment may be lower, but you'll pay more interest in the long run.

Considering the average cost of a new car in January 2021 was about $40,857, according to vehicle valuation and information source Kelley Blue Book, you would need a monthly income of $9,086.88, which is an annual income of $109,042.50, to stick to the 20/4/10 rule and spend $726.95 per month on the car loan payment, even if you have excellent credit. 

Adjusting your budget is another option for affording the monthly payment on a new car, if your other monthly expenses are low. If this is the case, you can increase the 10% part of the rule, allowing you to afford a car with a higher price tag.