Understand the 20/4/20 Rule to make your Car Loan Affordable
Car - The Only Eternal Love!
When it comes to cars, every American feels the same emotion of love. But, your emotion should not rule you during the car buying process. If you don’t consider your financial capacity, you may end up ruining your life. So, before starting your car loan shopping, use the 20/4/20 rule and determine how much monthly payment you can afford.
What is the 20/4/20 rule?
The rule consists of three elements that are essential for every car loan program. The elements are listed as follows:
1st Element) 20 - Down payment should be at least 20% of the total loan cost
2nd Element) 4 - Loan term should be four years or less
3rd Element) 20 – Total Monthly car expenses (loan payment, fuel, maintenance, insurance, etc.) should be 20% or less of gross monthly income
Here’s an example to make things clear. We will assume the following things:
a) Down Payment Amount = $ 4000
b) Gross monthly income = $ 3000
c) Monthly car expenses (excluding loan payments) =$150
d) Interest Rate = 4%
The 1st element (20% down payment) tells how much you can afford to spend on a car. As you can manage down payment of $ 4000, you can afford a car of $20,000 ($4000/20%).
The 2nd element just tells you that the loan term should not be more than four years.
The 3rd element informs that your monthly car expenses should not be more than 20% of your gross monthly income. Your gross monthly income is $3000, so 20% is $600 ($3000/20%). You will have $450 in hand after deducting the monthly car expenses of $150 (excluding loan payments). $450 is the amount that you can afford to spend every month on car loan payments.
Using auto loan rate as 4% and loan term of 48 months (or 4 years), the maximum loan amount that you can manage is $19,930.
Hence, the most that you can afford to spend on a car is $23,930 ($19,930 + $4000 of down payment).
What are the Benefits of the 20/4/20 Rule?
The benefits of the rule are as follows:
>> It will help you calculate total down payment amount beforehand giving you enough time to make arrangements for additional down payment if required.
>> It will manifest the gross monthly income and provide a clear picture of your financial condition.
>> Finally, it will show whether you can afford a loan program.
Now that you know the benefits of the rule, apply it whenever you need a car loan. It will help you in making an affordable choice.
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:- Posted by Admin on 19th November, 2014