Your loan rides on 3 numbers

The ageold 20:4:10 rule of thumb determines whether your budget will allow you to buy your dream car. It dictates factors such as time period and downpayment amount

In the internet age, getting information on the latest car has become very easy. Comparing car features and loan rates is a matter of a few clicks. But did you know there are three numbers you need to remember if you are taking a car loan. 20:4:10 is an old school personal finance rule for buying a car followed across the world. It helps you determine whether your purchase will match your budget before you fall in love with a vehicle you cannot afford.

NUMBER 20

This is the first number you need to remember, and it refers to the percentage of total amount that needs to be made as down payment. “For a car loan, 20% down payment is a reasonable amount. It shows financers that you have your skin in the game. Moreover, lenders will anyway ask you for some margin money. With 20% you will reduce your loan burden,” said Parag Paranjpe, a Nagpur-based certified financial planner.

If you pay a good enough amount in the beginning itself, you won’t need to take a large loan. At the same time, this percentage is not so large that you cannot set it aside.

Remember: when you borrow a smaller amount, the total cost of your loan decreases. Additionally, you’ll have smaller payments and possibly finance it for a shorter period.

NUMBER 4

The next number you need to remember is four, which is the ideal number of years you need to take the car loan for. There are lenders who allow you to borrow for a period of seven years. But that may not be the best choice when it comes to car loan. A seven-year loan works more in favour of the bank. “When it comes to taking a loan, a longer tenure should be avoided. Ideally it should be between three to five years. But with three years, the EMI burden would be higher, and cash flow might get impacted,” said Kiran Telang, a Mumbai-based certified financial planner. A five-year tenure impacts the resale value of the car. The value of a five-yearold will depreciate at a rate of more than 60%.

In short, think of it this way: If you can’t afford the monthly payment required to pay off the car in four years or fewer, it’s probably outside your budget. Plus, the resale value of a four-yearold car will be much better than the fiveyear-old clunker.

NUMBER 10

This is the ideal percentage of your monthly salary that should go towards servicing the monthly instalment of the car. Expenses including your car payment, insurance, gas and maintenance should be under 10% of your monthly income. “If it’s lower, it’s even better. Anything over 10% could easily put you into a debt trap,” Paranjpe said.

In fact, ideally not more than 30% of your monthly income should go towards servicing all your debts such as home loan instalments, car loan instalments and credit cards dues. “If your home loan EMI is around 20%, the remaining 10% can go towards car loan EMI and other EMIs,” Paranjpe said.

20:4:10 RULE

“The decision of buying a car and what financing options work for you depends on your individual circumstance or need. For instance, if you are buying it as a business expense or personal use, the finer details of your car purchase will differ. Simple generalisations won’t work in every case,” Telang said.

If you are buying a car, let this 20:4:10 rule guide you towards the right choice. Just in case you needs professional advice, do seek it. But for others, this festive season, make sure you follow some old traditions including this ageold financial rule.

20% OF TOTAL LOAN AMOUNT SHOULD BE MADE AS DOWN PAYMENT, NOT MORE THAN 10% OF YOUR SALARY SHOULD GO TOWARDS EMI, AND THE IDEAL LOAN TENURE SHOULD NOT EXCEED FOUR YEARS, SAY EXPERTS