Under new regulations, the maximum tenure for car loans is now capped at four years. This aims to prevent individuals from remaining burdened by debt for extended periods and encourages quicker loan repayment.
In today's world, a car is no longer a luxury item but a necessity. From commuting to work and school runs to family vacations, a car simplifies and enhances daily life. However, this convenience is only enjoyable when purchased thoughtfully and planned well. Poor financial decisions can lead to a car purchase becoming a debt burden, potentially causing financial instability.
A highly effective and practical formula is the 20/4/10 rule, which enables even middle-class individuals to afford their dream car without financial strain. This rule serves as an excellent guide for budgeting and debt management when buying a car.
What is the 20/4/10 Rule?
This rule is based on three key aspects: down payment, loan tenure, and the monthly expense limit. This formula ensures you maintain a balanced financial situation after purchasing a car without compromising other expenses.
20 Percent Down Payment on the Car's Price
The first part of this rule states that you should make a down payment of at least 20 percent of the total cost of the car. The main advantage is that your total loan amount decreases, saving on interest and reducing monthly installments.
For example, if you want to buy a car worth ₹10 lakh, you should deposit ₹2 lakh as a down payment. This means you will only need a loan of ₹8 lakh, preventing undue financial pressure.
Maximum Loan Tenure of 4 Years
According to this rule, the car loan tenure should not exceed four years. Customers often opt for longer loan terms to keep installments low, but this increases the overall interest paid. Shorter-term loans not only save on interest but also provide psychological relief from clearing debt quickly.
A 7-year loan might end up costing significantly more than the car's actual price. Completing the loan within four years strengthens your credit score and prepares you financially for the future.
Maximum 10 Percent of Monthly Income for Expenses
The third and most crucial aspect of this rule is that the total monthly car-related expenses should not exceed 10 percent of your monthly income. This includes EMI, maintenance, insurance, and fuel.
If your monthly income is ₹60,000, your total car expenses should not exceed ₹6,000. This leaves sufficient funds for other essential expenses and prepares you for emergencies.
Why is this Rule Necessary?
In India, most people buy vehicles using car loans. Without proper financial planning, this dream can become a financial burden. The 20/4/10 rule offers a way to avoid this situation. It not only helps in purchasing a car within budget but also helps maintain long-term financial balance.
According to Tata AIG Insurance, the price of the car you buy should not exceed 50 percent of your annual income. That is, if your annual income is ₹12 lakh, a car costing up to ₹6 lakh would be ideal. This rule reinforces this principle and prevents taking on excessive debt.
Peace of Mind and Better Financial Planning
Buying a car without extra burden allows for better management of related responsibilities. Timely installment payments are easier, and the ability to save for future needs remains. Many people become overwhelmed by EMIs and neglect car maintenance, leading to deterioration. The 20/4/10 rule prevents this dilemma.
Especially Beneficial for First-Time Car Buyers
This rule is even more useful for first-time car buyers. Often, people make emotional decisions when choosing their first car, exceeding their budget. This leads to regret later. However, the 20/4/10 rule helps ensure decisions align with income and expenses.
Caution Regarding Bank Loans and Interest Rates
When taking a car loan, it's crucial to compare interest rates and understand processing fees, down payment terms, etc. Attractive EMI schemes offered by banks can be more expensive in the long run. Taking a loan within the four-year limit helps avoid this trap.
Always Use an EMI Calculator
Before buying a car, use an online EMI calculator to determine your monthly installment. Also, check the total cost including insurance and maintenance to ensure it remains within 10 percent of your monthly income.
