Buying a car is not a small investment. With the average life expectancy of a car now being eight years, this vehicle will be with you a long time and will cover a hell of a lot of ground with you.
With this in mind, it’s good to remember the 20/4/10 rule as a rule of thumb to help you make good, level headed decisions when buying yourself a car. The premise is simple:
you should always put down at least 20% of the car value as a down payment, keep the length of the car loan to no longer than 4 years, and spend no more than 10% of your gross monthly salary on your car expenses.
Why these amounts?
20% down payment
By putting down 20% of the car's value you are doing two things. Firstly, by putting down more cash you are actually increasing the amount you need to borrow, thereby decreasing the amount of interest you will need to pay on your loan and freeing up more of your budget for savings and investments.
Secondly, you are much more likely to be approved for finance in the first place if you are able to put down a substantial down payment.
4-year loan length
By keeping the length of your loan relatively short you are not tying yourself to a car for too long. This means you will be free to sell it on or exchange it before it develops real problems, without losing money on it.
Additionally, by taking out a smaller loan you will more likely avoid the problem of your car value depreciating below the value of the loan.
10% of outgoings on vehicle expenses
All your vehicle expenses (including loan payments, petrol, insurance, and road tax) should come in at roughly 10% of your gross income for good reason. If you are regularly spending any more than that, then its highly likely you will not have enough money left at the end of the month to make savings.
Without building up a solid emergency fund or pension pot you are effectively living paycheque to paycheque. This makes you incredibly vulnerable to sudden changes in your financial situation. Additionally, as all cars depreciate in value the older they get, the money you are spending on it will not be ‘returned’.
Things to remember
Obviously this is just a rule of thumb, and will not always be applicable to everyone in every situation. However, by using it as a guideline you will have an easier time discerning between good and bad financial decisions.
Concentrate on buying a reliable car that fits your needs exactly, whether you need a small city run-around or a long distance hauler; something with a ton of boot space, or something that you can park in the tightest of spots. It's your car, concentrate on your needs.