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Buying a house is a pivotal financial choice and for many individuals, car purchase is the second most significant decision. A common approach to getting your favourite car is by applying for a car loan. The good news is car loan rates are record-low this time.

 Why not leverage the opportunity? Choosing a car loan depends on the best interest rates, money requirements and affordability. As simple as it seems, most individuals struggle to get the right amount and carry payments.

Thus, the 20/4/10 rule helps counter the difficulty. It helps determine the ideal amount to borrow by specifying the loan term and income percentage to devote- to your car-related dream.

What does the 20/4/10 rule imply?

The 20/4/10 rule can help car buyers decide whether they have the financial potential to buy a new car or not. According to this rule of thumb:

  • 20% of down payment
  • 4 years of repayment term
  • Spending less than 10% of your monthly income on transportation expenses

However, the general rule is to provide 20% of the down payment to reduce the payments. It is ideal for individuals seeking a car loan at affordable rates. Though one does not need to pay anything upfront on a car loan, he can pay some to get better interest rates.

Secondly, a 4-year of repayment helps you clear your loan quickly without paying extra interest. Alternatively, if you take a loan longer than 4 years, you ultimately pay more interest. Though your monthly repayments will be low. It may not be beneficial for your financial health in the long term.

The final thing of the 20/4/10 rule is to keep the transportation costs below 10%. Buying a car requires car insurance, fuel and repairs, owning a car, etc. Without this, you cannot get a car loan. Try to keep up with the car payments.

5 steps to calculate using the car loan amount to borrow with a 20/4/10 rule

If you want to buy a car using a car loan because of insufficient savings, the below tips may help. It helps you calculate the amount to borrow using the 20/4/10 rule. Let’s see the ways to accomplish it:

1) Calculate your gross monthly income

Gross monthly income is the amount before the deductions. It includes income from sources like investments, salary, rental payments, part-time income, etc. Lenders generally calculate your gross income to provide a loan. For example, if your monthly CTC is – €30000 with €1000 interest income and €12000 rental income, your gross income will be – €30000+€1000+€12000 = €43000.

  • Multiply gross income by 10%

Multiplying the gross income by 10% will help you know how much you can spend on a car purchase. For example, here, your gross income is €43000. By multiplying 10% by €43000, your answer will be – €4300. Thus, you should invest this sum in car-related expenses.

  • Subtract the other car-related expenses

Generally, car expenses include- MoT, insurance, oiling and repairing, gas, registration, etc. On average, you may need €2500 to prepare the car. Here, if you subtract 2500 from the maximum amount to spend on car repairs, it would be €4300- €2500= €1800.

4) Multiply the result by 12 to know the annual payment

It is one of the best and easiest ways to know your annual payment on car loans. You just need to multiply €1800 by 12, which is €21600. You must pay the amount towards the car loan per year. In this case, €1800 will be your monthly payment towards the car loan.

If you cannot pay the expense due to some emergency addition to the budget and refrain from checking other options due to low credit, check unsecured loans for bad credit scores. You can finance the short-term amount using the loan. It would prevent you from attracting costly penalties. No, individuals with regular income will not face any issues repaying the dues.

  • Lastly, Multiply the annual payment by 4

The number you get by multiplying the annual car loan payment amount by 4 is the amount you should loan up for a car purchase. In this case, multiply €21600*4. It implies you should borrow €86400 for the car purchase given the gross income of €43000.

Pros and cons of buying a car through the 20/4/10 rule

Though 20/4/10 rule guides owning a car through a car loan. However, the arrangement may not work for everyone. Here are some advantages and disadvantages of using a car loan:

Pros of 20/4/10 ruleCons of 20/4/10 rule
Putting a large down payment and opting for 4 year repayment period helps you save money on a car loanThis rule does not consider credit score. It is an important parameter to securing a car loan. Individuals with low credit may struggle to qualify
It helps build healthy habits like budgeting for a big-ticket item purchaseIt does not account for factors like inflation, car depreciation, etc., that play a major role in car finance.
It helps you have a better understanding of the loan amount to borrowCustomers may not save for 20% down payments or fall on loan payments during a sudden financial crisis

How do you benefit the most from the 20/4/10 car loan rule?

As mentioned above, the rule is just a guide, not a route to follow for every car owner dreamer. However, if you think it is a beneficial route for your finances, you can benefit from it in the following ways:

a) Save for a large down payment

Saving for a good down payment may be beneficial for all individuals, especially those with a poor credit history. It grants you an advantage on the loan terms while seeking the best bad credit car loans near you.  Before applying for a car loan, save enough for the deposit. It implies you should save for at least 6-8 months for the deposit and keep the amount untouched.

b) Stick to the base car model

While upgraded car models come with whistles and bells, they cost less and are easy to afford upfront. You can choose from a variety of base models within a similar car range.

c) Buy a used instead of a new car

Buying used car models usually requires a low deposit and is affordable. It may be ideal for individuals with a bad credit history.

Bottom line

Thus, the 20/4/10 rule states the basic concept of owning a car with a car loan. It helps you understand the amount you can afford to borrow and the expenses to expect on a new car loan. Eventually, you can apply for the right amount and follow payments without missing anything. Moreover, the concept is ideal for individuals with regular income.

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