Walking into a dealership for the first time can be daunting. From financing options to vehicle options and ongoing expenses, it can be hard to know where to set your budget. That’s why many financial experts suggest using the 20/4/10 rule as a baseline for figuring out how much car you can afford.
Foremost, before signing any paperwork, think about whether the car you are considering is really within your price range. To help first-time buyers avoid stretching their finances too thin to afford a car, there is a simple rule of thumb called the 20/4/10 rule.
In the simplest words, it is an easy to follow guide that will help first-time car buyers to make responsible choices while shopping for a vehicle.
What is the 20/4/10 Rule?
The 20/4/10 rule is a budgeting guide often used when buying a car with finance. It helps make sure the vehicle is affordable not just at the start, but for the full life of the loan.
It breaks down like this:
- Put down at least 20% as a deposit.
- Consider keeping the term to four years or less.
- Try not to spend more than 10% of your gross monthly income on total car costs.
Let’s look at each part a little closer.
1. Aim for a 20% deposit
The first part of the rule is to pay at least 20% of the car’s price upfront.
For example, if you’re buying a car for $30,000, a 20% deposit would be $6,000. That will leave you with $24,000 to finance.
A bigger deposit can help in a few ways:
- It reduces how much you need to borrow.
- It can lower your monthly repayments.
- It may reduce the total interest you pay.
- It can improve your chances of approval.
Saving a deposit can take time, but it can make a big difference to the overall cost of your car.
2. Keep the Loan Term to four years or less
The “4” in the rule refers to keeping your loan term to no more than four years, or 48 months, when purchasing a car. It’s true that longer loan terms can make repayments look more manageable each month. But there’s a catch; you’ll usually pay more interest overall. With a shorter loan term, you can:
- Pay off the car sooner.
- Save on interest.
- Build equity faster.
- Avoid still paying off a car that’s already lost a lot of value.
Yes, the repayments may be higher, but the loan can cost less in the long run.
3. Keep vehicle costs to 10% of your income
The final part of the rule is about keeping car costs to a reasonable percentage of your income.
As a guideline, all costs associated with the car should be no more than 10% of your gross income. This includes:
- Loan repayments
- Insurance
- Fuel
- Registration
- Servicing and maintenance
So, if you make $6,000 a month before tax, your total car costs should ideally stay below $600 a month, this will allow you to set aside money for other expenses like rent, food, and unexpected costs.
Why is this rule helpful?
Many first-time car buyers only consider the monthly payment when budgeting for a car. However, just considering the payment can be misleading because it does not account for other car-related costs.
The 20/4/10 rule is helpful because it encourages you to think about the car purchase in terms of the down payment, loan term, and other costs in addition to the payment. This can prevent you from getting a car that seems affordable but ends up being too much to handle on a monthly basis.
Common budgeting mistakes first-time car buyers make
Despite having a particular sum in mind that they are willing to spend, many first-time car buyers tend to face the problem of going overboard. Some of the major budgeting mistakes made by them are as follows:
- Considering only monthly repayments,
- not factoring in insurance and registration,
- underestimating fuel and maintenance,
- stretching out the loan and
- putting all the available savings as a down payment.
It is essential to remember that a car should be bought within the budget and should not become a burden after the thrill of the new purchase dies down. The following suggestions may help in figuring out what can be afforded and what cannot.
How to figure out what can be afforded
Before jumping into the car-buying process, it is essential to understand the monthly budget in detail. To do so, one should calculate their monthly income and subtract all the monthly expenditures, including the amount that one wishes to save.
This will give a clear idea about the amount that can be spent on a car. The following tips are likely to help one stay within the budget:
- Not getting seduced by the idea of a dream car,
- taking into account all the expenditures associated with the ownership of the vehicle,
- buying from a private seller where possible,
- allowing some time to think through the decision, and
- not using all the available savings on a down payment.
Thinking about the affordability of vehicle ownership
The amount of money that goes into buying the car is only one aspect; there are various expenses that come along with the ownership of the vehicle. First-time car buyers in Australia should be aware of the additional expenditures that come with the ownership of the vehicle. Some of the major ones are as follows:
- Comprehensive car insurance,
- Registration and compulsory third-party insurance,
- Petrol or charging costs for the car,
- Servicing,
- Tyre replacements, and
- Other maintenance and repair costs.
With this information in mind, one can figure out a realistic amount that they can spend on the car.
New vs. Used Cars
According to experts, a used car is a fantastic option for a first-time buyer. This is because, compared to new cars, it requires a smaller loan, has a lower percentage of depreciation, and comes with cheaper insurance.
However, one must keep in mind that new cars possess the latest technologies and features, including safety functions. Moreover, it will also require lower maintenance costs, especially in the first few years after purchase. Therefore, the choice between a new and used car depends on the individual needs and preferences of the buyer.
Getting a finance quote prior to buying the vehicle
When it comes to the purchase of a car, many buyers tend to first decide about the vehicle that they wish to buy and then look for a suitable finance option. However, getting a finance quote before buying a car allows one to understand the amount that they can afford. This will, in turn, help in short-listing the car models that fit within the monthly budget. Therefore, it may be a good idea to get a finance quote before buying a car in order to get an idea about the borrowing capacity. This way, one gets an accurate idea about the car that they can actually afford to buy, instead of facing heartbreak when the dream car does not fit within the finance quote.
Final Advice
Buying the first car can be exciting, but one must not get carried away by emotions and must ensure that the purchase does not exceed the set budget. One of the best ways to do so is to follow the 20/4/10 rule while also taking into account the suggestions mentioned above. Taking the time to think through the purchase and associated expenditures may not be the most exciting thing to do, but it surely helps in making vehicle ownership a pleasant experience for years to come.
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