How much car can you afford? Many people wrestle with this question, but financial personality Humphrey Yang recently broke it down to a simple formula. Knowing how much you can truly afford can help you avoid an expensive vehicle that ends up being more trouble than it's worth.
The 20-4-10 rule has three components, and each of them influences how much you can spend on a car. Yang broke it down in a recent video while outlining practical strategies to keep your transportation costs low.
Dissecting The 20-4-10 Rule
Each number in the formula plays a key role. Yang believes you should put 20% down, finance a car for no more than four years, and ensure that your monthly car payments do not exceed 10% of your gross monthly income.
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Many dealers and lenders give you the option to put no money down, but you can get stuck with a car that eats up too much of your budget. Furthermore, if you don't put any money down, you will pay a lot more interest over the long run.
The first two metrics are straightforward, but Yang also includes insurance and maintenance in the monthly payments. If you have a $750 monthly auto loan payment, but you also spend $200 per month on insurance and maintenance, your monthly car payment is really $950. Yang uses this number to calculate that you should gross $9,500 per month if you want to incur a $950 monthly car payment, including insurance and maintenance.
Car Payments Are One Of Your Biggest Expenses
Yang's calculator results in a monthly car payment that reaches 10% of your gross monthly income. Some people put a higher percentage of their income toward their vehicle, especially for luxury models.
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Not taking this decision seriously can result in unnecessary financial hardship. A car is the second-most expensive purchase you will likely make, outside of buying or renting a house. That's why it is extra important to run the numbers and strictly follow a framework like the 20-4-10 rule.
When most people think of cutting their expenses, they think of ditching their daily coffee habit. While removing any cost will benefit your finances, Yang suggests focusing on the big-ticket items like a house and a car. If you're overpaying for your house and car, then skipping Starbucks won't have much of an impact on your finances.
How To Reduce Transportation Costs
Yang wrapped up the video by summarizing some of the ways you can reduce your transportation costs. Cutting these expenses will help you save a lot of money. You can use that extra money to grow your portfolio faster, go on an extra vacation, or give yourself peace of mind with a six-month emergency fund.
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Yang mentioned buying a used car, using public transit, carpooling, and riding a bike as some of the ways to reduce your transportation costs. Some old models still have a lot of life in them, and it's even possible to find an old model that's more reliable than a new car.
Using public transportation, carpooling, or riding a bike from time to time can help you save money on parking costs. These are frugal decisions that can protect your wealth. Being frugal and aggressively investing money now can set you up for a robust financial future.
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