What is the car payment rule?

Auto Loan Calculator: See How Much You Can Afford

For most consumers, buying a vehicle comes down to calculations:

• What’s the monthly payment?
• Will the car hold its value?
• What will it cost to insure?
• What are its gas-mileage projections?

And, above all: Can I Afford it?

To work out the last — and most important — of these considerations, we’ve provided an auto loan calculator. It offers everything you need to pinpoint your ballpark payment schedule, based on four variables:

1. Down Payment
2. Desired Monthly Payment
3. Annual Interest Rate
4. Length of Loan (in months)

Auto Loan Calculator

Let’s consider each category individually.

Vehicle Down payment

This is the amount you will apply toward the purchase price to reduce the amount financed. A down payment can include any combination of cash, trade-in or — when available — a dealer or manufacturer rebate.

Use online sites to help provide an idea of your car’s trade-in value. Regarding the pricing guide, make sure to use the trade-in value and not the retail cost (the dealer’s resale price).

Pro tip

Be brutally honest in assessing your vehicle. When in doubt, grade it down. That way you’ll be less dismayed by the report of the dealership’s used-car inspector. If it comes to that, you’ll also be in a better position to argue that the dealership’s appraisal is overly harsh.

The bigger the down payment, the better off you’ll be, for a number of reasons. Having lots of skin in the game allows you to shop for a better vehicle, or could lower your monthly payment, or could reduce the length of your loan (or all three). A fatter down payment can even lower the interest rate on your loan.

For new cars, which suffer notorious hits the moment they’re driven off the lot, a 20% down payment will prevent you from being “upside-down” — owing more than the car is worth — the instant you take possession.

Why is that important? If your car is stolen or totaled in the first couple of years of ownership, you could be on the hook for the difference between what insurance is willing to pay and what is remaining on you loan.

If you’re not that sort of risk-taker, the alternative would be gap insurance, purchased through your regular insurance agent. Be wary of buying gap insurance from dealers, who not only add breathtaking markups on the stuff, but will roll it into your loan so you end up paying interest on it.

Desired Monthly Payment

With serious consideration given to the length of the loan or lease, of course, the desired monthly payment is pretty much the total ballgame. It is the figure the dealership will target. It is the number that will be a fixed point in your financial world for the life of the loan or lease.

Things to consider beyond the monthly check you’ll stroke (or have automatically deducted) that are very much part of your auto-owning experience are the costs for insurance, gasoline, maintenance, fees, tolls and parking.

Generally, financial advisors advise against total vehicle costs topping 20% of take-home pay. Payments themselves, whether principle and interest or lease installments — but not insurance — should account for half that, or 10%.

Now, about insurance. Your premium will constitute a substantial portion of your car-owning costs. As with all consumer products, you should shop around. Begin by knowing your state’s minimum requirements, as well as those of the financing or leasing agency.

Review your driving record. Are there problems that can be cleaned up? What’s your current coverage? Does it require adjusting?

To cut to the chase, check out edmunds.com’s “How Much Car Insurance Do You Need.”

For estimates, submit “shop car insurance quotes” to your favorite search engine. Esurance, Edmunds, Money Supermarket and NetQuote are among the top providers.

Annual Interest Rate

As with most loans, your credit score and credit history will influence how low your interest rate will be.

Other factors include the length of the loan (longer terms tend to command higher rates, because the lender is at risk for a longer time), the type of lender — bank, credit union, automaker’s financing arm — and whether you’re buying new or used. New cars traditionally can be financed at lower rates.

Term of the Loan

It ought to go without saying that the shorter the length of your vehicle loan, the better. Yes, all other variables being equal, the longer you take to pay, the lower the monthly payments will be.

But other important factors to consider are the amount you’ll pay in interest on longer-term loans, how long you’ll be paying off your vehicle after its warranty runs out, and, because of depreciation, how long your loan balance will be higher than the value of the car.

Buying vs. Leasing: Generally, it costs more to buy a car than to lease one, but the upside is at the end of the purchase arrangement, you own something. At the least, if you’ve followed prudent advice on down payments and length of the loan, you will have equity in your vehicle if you get the new-car itch.

Leasing involves lower out-of-pocket monthly costs because you aren’t buying anything; you’re simply absorbing the vehicle’s depreciation during the term of the lease, plus interest (or rent) charges, taxes and fees.

Buying involves a down payment. Assorted upfront leasing costs can include the first month’s payment, a refundable security deposit, an acquisition fee, a down payment (for lower payments), taxes, registration, and other fees.

ConsumerReports.org details other differences, but they all orbit a central theme: One way the vehicle is yours; the other way it still belongs to the dealership.

Buy, and the vehicle is yours, to have, hold, drive, customize and, ultimately, dispose of as you see fit.

Lease, and you have to return it essentially as you received it, plus allowable mileage. Think of it as getting a car from Hertz or National, just for a really, really long weekend.

How Much Car Can I Afford?

As we have described in the previous sections, there is much that goes into deciding how much vehicle you can afford. Down payment. Savings. Available monthly cashflow. Potential for increasing your income. Other expenses.

Auto Financing Rule of Thumb: 20/4/10 formula

The closest thing to magic sauce is the 20/4/10 formula endorsed by many advisers: 20% down, no longer than a four-year term, and total vehicle expenses of 10%. This is prudent, happy-life advice.

Plug those numbers into our calculator, and you will get a good idea of how much vehicle you can maintain.

Buying a car is a big financial commitment. Here’s how to calculate how much you can afford

Many consumers are feeling the financial pressure of rising interest rates as they shop for new cars.

Photo illustration by Fortune; Original photo by Getty Images

Certain big-ticket purchases can be delayed until you can afford it later on.

But for many Americans, the purchase of a new car is sometimes a non-negotiable if they rely on a vehicle to get to work, get their kids to and from school, or don’t have a reliable public transportation system to lean on.

Determining how much you can comfortably afford will ultimately depend on your personal budget. And even then, with car buying costs having increased significantly, many buyers are finding themselves stretching their budgets to the limit in response to interest rates and rising sticker prices.

The cost of becoming a car owner has increased

Edmunds data from November 2022 showed that the average transaction price for a new vehicle hit a record high of $47,681 in November 2022—but this was also the first time since July 2021 that the average transaction price came in below the average MSRP (sticker price). In November 2022, the average MSRP dropped to $47,696. Experts noted that this drop in price predominantly impacted larger trucks, SUVs and luxury vehicles, but lower-priced vehicles still saw an increase in price and demand.

“Car-buying costs are definitely on the rise,” says Andrew Stuart, EVP, TD Bank AMCB, Head of TD Auto Finance US. “Some of the contributing factors include rising interest rates and the cost of vehicles themselves. Safety and technology advances in automobiles, combined with investments in hybrid and battery electric drivetrains have steadily increased the average cost of a new vehicle. Part of this is being driven by historically low new vehicle supply as a result of the pandemic’s impact on supply chains. If dealers do not have a strong supply of inventory, they are less willing to negotiate on price.”

With higher interest rates becoming the new norm, many car buyers are settling for higher monthly payments. The same Edmunds report showed that 15.7% of consumers who financed a new vehicle in Q4 2022 committed to a monthly payment of $1,000 or more—the highest it’s ever been—compared to 10.5% in Q4 2021 and 6.7% in Q4 2020.

Figuring out how much car you can afford

Buying a car is a massive financial undertaking and should be carefully thought out. Experts suggest weighing the following factors when making your financial game plan for your purchase:

Consider your monthly budget

The amount you can afford to pay for a vehicle will depend on your budget. As a general rule of thumb, many experts suggest following the 20/4/10 rule, which holds that you should set aside 20% of a car’s purchase price for a downpayment, take 4 years to repay your car loan, and ensure that your monthly transportation costs don’t exceed 10% of your monthly income.

These are just guidelines, but it can be helpful to use these parameters to figure out how much you can comfortably afford to pay upfront, and how much you can afford to spend on recurring car-related expenses.

“Determine your after tax income,” says Stuart. “Transportation expenses should be considered along with housing, food, entertainment savings etc. Once you determine the amount your individual circumstances will allow you to spend on transportation, think about the other expenses beyond your car payment that should be a part of your budget. This will include things like insurance, fuel and maintenance expenses.”

Think about all of the costs you’ll be responsible for apart from your monthly payment

Other considerations may include an extended warranty to cover costly repairs that could crop up, or gap insurance, which, in the event of an accident, covers the difference between what your vehicle is currently worth and the amount you actually owe on it.

Insurance, fuel, and maintenance costs can be drastically different depending on the vehicle you’re interested in purchasing. And if you plan to finance that vehicle, which most buyers do, your credit score will play a major role and the interest rate you can secure on an auto loan.

Taking the time to compare financing options before you decide on a vehicle can help you determine which of your options is the best route to take long-term, how that payment will factor into your monthly budget, and how long it will take you to repay that loan at the current rate.

“Other options to think about is to secure financing outside of the dealership,” says Joseph Yoon, Edmunds’ consumer insights analyst. “Say you’ve been going to the same bank for a while, or there’s a local credit union that’s running some special interest rates for new car purchases, I think that’s a good way to kind of flip the table in your favor just a little bit, even if it’s by a couple points because it adds up.”

Use a loan calculator tool to crunch the numbers

There are several online calculators that can help you determine if your car payment will fit neatly into your monthly budget. Typically, you’ll need to provide your credit score range, price of the car you’re considering, loan terms, the interest rate you’ve been quoted, and the value of your trade-in vehicle if you have one.

“There’s plenty of loan calculators out there that you can use to figure out the ballpark of what your monthly payment is going to be when you’re trying to figure out ‘does this car fit into my budget or not?’” says Yoon. “And most manufacturer websites do advertise their current interest rate so that’ll be something of a reference point.”

3 tips for cutting your car-buying costs

While there’s no way to control the sticker price of the car you’re interested in purchasing, there are moves you can better position yourself to secure the best deal on your vehicle.

1. Boost your credit score. When it comes to your auto loan rate, your credit score plays a major role in how likely lenders are to offer you a lower rate or not. “Higher credit scores will generally receive a more favorable rate. I would always recommend that a first time buyer know their credit score before they start to negotiate rates on a car loan,” says Stuart. There are a number of convenient ways to check your credit score, and if you find that your score is lower than you anticipated, you can request a free copy of your credit report from each of the three major credit reporting agencies each year. Reviewing your report can give you a more in-depth look at the factors that could be hurting your score so that you can make a plan to improve it before you head to the dealership.
2. Make a larger down payment. If you can afford to make a larger down payment on your vehicle, experts agree that it pays to do so. “Coming in with a 10% down payment and a strong credit score will put a first time buyer in a very good position to obtain a market competitive rate,” says Stuart. “With that said, it’s not just the rate that should be considered. Think about how much payment you can afford as you are making your car buying decision. It may make sense to accept a slightly higher rate over a longer term to get a payment that fits your individual budget.”
3. Use your current vehicle as leverage. Don’t let the new car smell distract you from the value your current vehicle holds. You could significantly reduce your upfront and long-term costs by trading in your vehicle. “If you’re trading in the car that you used to drive, try to leverage that as much as possible. And hopefully that one is paid off so you’re not rolling bad equity into a new loan,” says Yoon. “That will be your biggest bargaining chip to get a good deal.”

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How to buy a car with the 20/4/10 rule

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.