20/4/10 Car Buying Rule Explained: Smart Budgeting for Your Next Car

One of the most important financial decisions a person or family makes is buying a car. Due to the significant financial outlay involved, buying a car typically comes in second to buying a home or other real estate. 20 4 10 car buying rule ensures your finances are not overwhelmed by the thrill of buying a new car.

Therefore, an essential chapter of personal finance comes into play when you decide to purchase a new vehicle. Hence, this well-established car buying rule called 20/4/10 is helping many professionals to plan their finances. This rule for car purchase will help you avoid paying excessive interest, strain your monthly budget and also from falling into negative equity. 
 

What is the 20/4/10 Car Buying Rule?

The 20/4/10 car buying rule is a financial guideline that suggests how much you should spend on a car relative to your income. It provides a clear financial structure and plan for how you should go about managing your car loan. In essence, the 20/4/10 rule suggests buying a car while following a calculation of 20 per cent down payment, a 4-year loan tenure and 10 per cent of your monthly income towards your car EMI. Here is the complete explanation of the 20/4/10 car buying rule.

1. 20 per cent down payment - During your research, many banks and financial institutions will attract you with the highest possible loan eligibility for your new car. The car buying rule suggests that you should make a down payment of 20% of your car’s on-road price. If your car costs ₹10 Lakh on-road, you must aim to pay a down payment of ₹2 lakhs. 

2. 4-year loan tenure - Extending your car loan tenure to beyond 4 years can lower monthly EMIs, and might sound convenient, but the overall interest payment can be very high.

3. 10 per cent income for monthly EMI-  This part of the car buying rule tells you to limit the EMI to a maximum of 10% of your monthly income. While running and maintenance costs can be variable and cannot be accounted for with ease. Limiting EMIs can help you plan your finances relatively easily. 

The 20-4-10 car buying rule might seem fairly straightforward, but it also limits your options for cars. Let’s get into further details with an example.

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

To understand how the 20/4/10 car buying rule shapes your budget, let’s take a simple example. Suppose your monthly take-home income is ₹1,00,000. According to this rule, your maximum EMI should not cross 10% of your income, which in this case comes to ₹10,000 per month. We also follow a loan tenure of 4 years and a 20% down payment on the car’s on-road price.

If we calculate the numbers using an average 9% interest rate, a ₹10,000 EMI over 48 months gives you a maximum loan amount of around ₹3,90,000. Since this loan should only cover 80% of the on-road price, the ideal on-road price for your next car should be around ₹4,87,500.

At this budget, your 20% down payment comes to roughly ₹97,500, and the total interest paid over 4 years stays around ₹90,000. This helps you understand the real cost of ownership before you make a purchase decision.

Most professionals who follow this rule actually saw their finances remain healthy throughout the loan duration. The 20-4-10 rule for a car keeps your down payment manageable and makes you pay less interest.

The car options that you have with an income of ₹1 lakh per month within the 20-40-10 car buying rule are:

• Maruti Suzuki Alto K10
• Maruti Suzuki S-Presso
• Renault Kwid

20% Down Payment in 20/4/10 Car Buying Rule

A down payment is the initial amount of money, outside the loan component, that you pay upfront when purchasing a car. A 20 per cent down payment is significant, but it reaps numerous benefits in the long run.

Lowers the loan amount - By paying 20 per cent of the car’s price upfront, you reduce the amount you need to finance. This, by far, is the most helpful aspect of a larger down payment sum.

Lowers monthly payments - A knock-on benefit of the ₹1 lakh down payment in our example would now mean that interest on the loan amount is reduced. Thus, instead of paying interest on the total on-road price, you now pay interest on ₹3.9 lakh. This will reduce your monthly instalment payments. Your overall monthly costs on the car will reduce, and this will help you manage your monthly expenses better.

Reduces overall interest costs - A lower loan amount also means you’ll pay less interest over the tenure of the loan. Interest is calculated based on the principal amount, so reducing that principal by making a significant down payment will save you money in the long run.

Avoids negative equity - Cars depreciate the moment they leave the showroom, thus factoring it in is vital. Negative equity occurs when the value of your car drops below the amount you still owe on your loan. This can happen if you finance the entire purchase price of the car with little to no down payment. Making a 20 per cent down payment helps protect you from being in this unfavourable financial condition. This is especially relevant if your choice of car has poor resale and depreciates faster than others.

4-Year Loan Tenure in 20-4-10 Rule

Sticking to a 4-year loan term requires careful planning and discipline. This is an important aspect because stepping outside the 4-year loan tenure stipulation will have consequences on your monthly expenditure on the car. A lower monthly EMI upon choosing a longer loan duration can be lucrative, but it will amount to a higher amount of total interest paid, plus doing so will also risk running into negative equity. There are some steps you can take to discipline yourself into a maximum of a 4-year loan term.

Choose an affordable car - One of the best ways to ensure that you can stick to a 4-year loan term is to choose a car that’s lower in price than the 50 per cent budget as stated earlier. Focus on finding a vehicle to fit in this set budget, thus lowering your down payment requirement as well as the loan amount and the monthly EMI.

Increase your down payment - The 4-year element of the 20/4/10 rule of car buying is vital, so giving it more importance will prove beneficial. If possible, opt to put down a larger sum of money as a down payment rather than extending the loan tenure. This will, in turn, reduce the principal amount of the loan, making it easier to stick to a 4-year term with manageable monthly instalments.

Shop around for the best loan offers: Different banks offer different interest rates and loan terms. Taking a loan at a suitable mix of lower interest rates over a period of four years will make it easier to stick to a 4-year loan term.

10% Monthly Income as EMI in 20-4-10 Car Purchase Rule

The final component of the 20/4/10 rule for car buying is the 10 per cent dedicated to EMI of your car. This element ensures that your car’s EMI doesn’t take up a large portion of your monthly income, as other car-related expenses such as fuel, service cost, insurance, etc, are not factored in.

In the example we shared above, your car’s monthly EMI must not exceed 10% i.e., ₹10,000 per month, to accommodate a breathing space for fuel costs, surprise repairs, scheduled service and maintenance of your car. 

Strategies to Use 20/4/10 Car Buying Rule

As we saw in the example above, the 20/4/10 rule can feel a bit restrictive at first glance. With a monthly income of ₹1,00,000, the rule allows an EMI of only ₹10,000, which limits your ideal on-road price to around ₹4.87 lakh. This means that, with this rule for buying a car, your car choices are restricted to around 50% of your annual income.

Therefore, following this car buying rule, at a 1.5 lakh per month income, you should be able to pick a car with an on-road price hovering around 7.5 lakhs and 10 lakhs if your income is 2 lakhs per month.

But if your preferred car exceeds this calculated budget, there are still smart ways to work around the rule without straining your finances. 

Here are the strategies that help you stay as close as possible to the 20/4/10 car buying rule while exploring better options.

Consider other car options: You can look at a lower variant of the model you are planning or switch to the base variant. You can also consider a used car, which may fall comfortably within the ₹4.8 lakh range while still giving you the features and comfort you want. A well-maintained second-hand car can stretch your money far more effectively than a new one.

Increase the down payment percentage: The best way to pick a car with a higher price tag is to increase the down payment so that your EMI falls around 10% of your monthly income. It is because EMIs will stick to your monthly budget planning for the next 4 years. But you can wait for a few months and accumulate more to pay a higher down payment.

In our example, the 20 per cent down payment comes to roughly ₹97,500, giving you an ideal on-road price of around ₹4.87 lakh. But if you increase the down payment, your budget increases while the EMI stays within the ₹10,000 limit.

For instance, raising the down payment to 30 per cent lets you pick a car worth about ₹5.57 lakh, with a down payment of ₹1.67 lakh. Increasing it further to 40 per cent increases your eligible car price to around ₹6.5 lakh, requiring a down payment of about ₹2.6 lakh. This is the most practical way to stretch your budget while still following the 10 per cent EMI and 4-year loan tenure rule.

Research and evaluate other loan options: In addition to the car variants and down payment changes, the interest rates also vary across lenders. Interest rates vary across lenders, and even a small drop can make a noticeable difference to your total loan cost.

In our example, with a 20 per cent down payment, you take a loan of ₹3,90,000 for 4 years. At 9%, the total interest paid is roughly ₹75,800. If you secure a slightly lower rate, the savings become clear. At 8.5%, the interest drops to around ₹71,400, saving you about ₹4,400. At 8%, the interest goes down further to about ₹67,000, saving you nearly ₹8,800 compared to the 9% loan.

Potential Drawbacks of the 20 4 10 Rule for Car

The 20/4/10 rule, although helpful in setting baseline budgets for your car purchase as well as its running cost, can be vastly limiting. Our running example proved the same and deemed it unfit to buy a ₹10 lakh car with the 20/4/10 car buying rule applied. As mentioned, it is best to treat the rule more as a guideline than a hard and fast financial application. 

For instance, there may be merit in considering the ex-showroom price instead, as registration, insurance and other charges make up the on-road price is mostly a one-time expenditure. This difference in ex-showroom and on-road price can be absorbed in a down payment addition. Consequently, this will lower the loan amount required, thus the monthly EMIs, while you still get to buy the car you originally planned for. Some of the drawbacks of the rule are,

Limited options: The 20/4/10 car buying rule can narrow down your choices quickly, as seen in the example above. You may need to compromise on the model, variant or features you initially wanted, simply to stay within the recommended budget.

Higher down payment challenges: Saving anything above 20 per cent down payment is not always realistic. Your present finances may not allow it, even if your future income is likely to improve. On the other hand, waiting longer to save more or pushing for a higher down payment can make you miss a good deal or delay the purchase when you genuinely need a car now.

Rigid loan tenure and expense limits: The rule fixes the loan period at four years, but some buyers may receive a better interest rate for a five-year loan tenure, which balances out the higher overall interest. A strict 4-year tenure can also feel tight for people with lower incomes or multiple ongoing financial commitments.

Running cost variations: With EMIs being 10% of your monthly income, the running and maintenance costs might add up to a lot. You might use your car more in some months than others. If you value driving experience more than just owning a car, you might end up putting more money into accessories, aftermarket parts and better car care.

When to Use or Avoid the 20/4/10 Car Buying Rule

While the 20 4 10 rule for cars aims to stabilise your expenses on a vehicle, there are various scenarios where the rule might be best avoided. Conversely, the rule makes the most sense for buyers with a high level of financial control and prioritisation on limiting expenses.

Sometimes, a car purchase might be an entirely emotional decision, and that’s alright too. The rule may not be entirely applicable in this case. Whatever the scenario, the 20/4/10 rule can always act as a baseline for sound financial planning around buying a car.

Use it -

• If you closely track your finances
• If you have to stick to a certain monthly budget for expenditures
• If your choice of car isn't based on very focused needs
• If long-term investment is more of a priority
• If you are a first-time car buyer with little to no knowledge of the running costs of a car
   

Avoid it -

• If you don’t have a regular stream of income
• If your financial situation limits your savings
• If you foresee getting better financial aid to foreclose your loan
• If you have higher financial liabilities

If your selection of a car and its features cannot be compromised upon
 

Final Thoughts

Buying a car is a financial decision as much as it is about deciding on what car to get. The former requires a fair amount of individual financial assessment to reduce the financial burden of such an expenditure. This becomes even vital considering that cars start depreciating as soon as they roll out of the showroom floor. The 20-4-10 car buying rule helps you manage your car expenses within a stipulated budget, avoid unnecessary debt and maintain financial stability.

This rule helps eliminate the financial stresses of the purchase and becomes a set of guidelines to keep in mind. It can be modified to suit your situation and isn’t a hard and fast rule. Rather, it only provides the means to make a sound financial decision to help you further enjoy the experience of buying a new car.   

Got a car-buying hack for yourself? Share it with the CARS24 auto community, AUTOVERSE, where there are more interesting automotive discussions taking place.