What is 20/4/10 Rule For Buying a Car?

Posted on: May 21, 2024 | 3 mins | Written by: HDFC ERGO Team

What is 20/4/10 Rule For Buying a Car?

Do you want to buy a car? Have you heard about the 20 4 10 rule for buying a car?

When one becomes independent in life and starts earning, usually the two major purchases one wishes to make are buying a house and secondly a car. The sequence can change depending on personal goals. In the present times, buying a car, especially for those who do long commutes to work is a priority. The decision to buy a car comes with many other choices like which car, the model, the accessories and of course the colour but most importantly is the major decision of how to fund the car.

Fulfilling dreams is important but one needs to be careful and ensure there is no financial burden. For this there is a simple rule that has been used by many and is a great tool to know. This is called the 20 4 10 rule for buying a car. Let us understand this rule in detail.

What is the 20/4/10 rule?

Before you decide about purchasing the car, there is a rule you should keep in mind and follow and this is called the 20/4/10 rule. The tool is used to plan the financing of the car and will in the long term ensure financial stability as this explains how to use the funds in an appropriate manner and get the maximum benefits.

The car buying rule has three parts. These are:

1. Down payment:

As per the rule, 20% of the on-road price of the car should be paid as a down payment. The on-road price of the car will include all costs, taxes and comprehensive car insurance. Third party insurance is mandatory as per law in India, but the own damage component is a choice and so is the add-on coverage that comes with it. Once you know the amount it will cost the car and pay 20%, you will have paid 1/5th of the cost, thereby reducing the loan amount and thus, reducing the EMI, further reducing the financial strain.

2. Tenure of the loan:

The second and very important aspect to consider is the tenure of the loan. This is the number of years for which the loan is taken. The loan has to be repaid during this time by monthly instalments or EMI. As per this car buying rule, the loan should be taken for a maximum of 4 years. This will reduce the interest that needs to be paid to the bank and ensure better financial planning.

3. Monthly expenses:

Besides the EMI of the car loan, the car requires other expenses to ensure its smooth running. As per this rule, you need to ensure the sum of the EMI and the monthly cost should not exceed 10% of the monthly income. This will ensure that there is no compromise on other essential things because of the expenditure on the car.

How does this formula work for buying a car?

Now that we have understood the basics of this car buying rule, let us understand the 20 4 10 rule for buying a car with the help of an example.

Mr. Seth has a monthly income of Rs.3 Lakhs and thus, he earns Rs. 36 Lakhs in a year. If he intends to buy a new car worth Rs.15 lakhs, the following should be his calculation as per the rule:

Down Payment (20%)	Rs. 3 Lakhs
Tenure	4 years
Monthly expenses	Rs. 30,000 (10% of Rs. 3 lakhs)

Let us assume, the rate of interest is 8%, then the EMI on an amount of Rs. 12 lakhs for a loan period of 4 years should be about 29,000. To this, you will add other expenses and as these will exceed Rs. 30,000, and thus, this does not make sense. Mr. Seth will need to reconsider his decision and buy a more affordable car.

This car rule is mainly to ensure that the car being purchased is affordable and will not cause any financial burden.

Benefits of 20/4/10 car affordability rule

When you buy car insurance online, your aim is to ensure the premium is affordable and you do not compromise on coverage causing a financial strain. Similarly, when you intend to finance a car by taking a car loan, you need to be careful, that the loan does not stress you financially. This is why the 20 4 10 rule for buying a car should be used as it has many benefits for mental and financial peace. Some of the main benefits of this rule are:

1. Mental peace:

Financial strains can cause a lot of stress to an individual. But when you make an informed and careful decision, the chances of a financial strain are reduced and you can work around your budget easily.

2. Loan amount:

As per the car buying rule, you will pay 20% of the car price as a down payment, and this will reduce the loan amount and thus, reduce the EMI. This ensures you do not take a higher loan amount and stress yourself later to pay it.

3. Ensures improved budgeting:

In today’s world of rising costs and expenses, budgeting is essential. When you plan the car purchase keeping in mind the monthly costs, you will be able to control the expenses and also ensure that you are not spending outside your means. Also when you have planned certain expenses, planning the other things becomes easier.

Drawbacks of 20/4/10 car financing rule

Though the 20 4 10 rule for buying a car is a good rule to follow, it has some drawbacks also. Some of these are:

1. Increased burden:

The rule recommends a 20% down payment, which can be a considerably high amount for an individual. People have different responsibilities and thus, limited savings and thus, to give the amount in one go can be a big issue. Also, as you take a loan for a tenure of 4 years, the EMI can be high and might result in a monthly financial burden.

2. Limited options:

If one follows this rule, the options for cars are reduced. You need to stick to a price range and thus, you might need to compromise on the car or accessories.

3. Cost of Maintenance:

The cost of maintaining the car can change every year and the fuel cost is bound to change. This defeats the purpose of the 10% rule as the monthly cost will change.

When to use or avoid the 20/4/10 car buying rule

One should use the 20 4 10 rule for buying a car if they have:

• Stable income

• Buying their first car

• Can track expenses

• Make and stick to a budget

The rule does not work for:

• People with unstable income

• People with limited savings

• People with other loans and debts

Conclusion

When you decide to buy a car, the major decision is not the car but the finances. To ensure the purchase does not stress you financially, you should use the 20 4 10 rule for buying a car. With this rule and good and comprehensive car insurance, you can ensure you are financially secure. You can buy your car insurance online and save money. Plan your finances better and you will drive your car stress-free and enjoy the drives with your loved ones.

Disclaimer: The above information is for illustrative purposes only. For more details, please refer to the policy wordings and prospectus before concluding the sales.

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