How much car can you actually afford?

Car affordability has an unusually clean rule of thumb, and unusually little agreement about what the rule is for. Start with the rule, then with why a lender's answer is bigger.

The 20/4/10 rule

• 20% down
• 4 years of financing, maximum
• 10% of gross monthly income, maximum, for all car costs

The third number is the one people get wrong. It is not the payment — it is the payment plus insurance, fuel and maintenance. All of it, inside 10%.

Each part is doing specific work:

20% down puts you ahead of the depreciation curve immediately. It is the most direct defence against being underwater, because the loan starts below the car's value rather than at it.

Four years keeps the loan shorter than the steep part of depreciation. The 72- and 84-month terms that dominate new-car lending exist to make expensive cars produce affordable-looking payments, and they guarantee years of negative equity along the way. See how fast a car loses value.

10% of gross, all-in is the part that prevents a car from crowding out everything else. Insurance alone can be $150 a month, fuel another $150, and a payment that looked fine at 10% is at 16% once the rest is counted.

It is a conservative rule and many people will not meet it exactly. Used as a direction rather than a pass-fail test, it is one of the better rules of thumb in personal finance.

Why the lender's number is bigger

An auto lender is assessing the risk you stop paying them. That is a narrower question than whether the car fits your life.

Lenders look at your income, your existing debt payments and your credit score. They do not look at what you save each month, what childcare costs, whether your income is stable, or whether you were already stretched before you walked in.

They also lend against the car, which they can recover — so their tolerance for a marginal borrower is higher than yours should be.

The car affordability calculator shows both figures: what a lender is likely to approve, and what the 20/4/10 rule supports. The gap between them is the margin you are being offered and do not have to take.

What a trade-in you still owe on does

If your current car is worth less than the loan on it, the difference does not disappear when you trade it. It gets added to the new loan.

That has three effects, and they compound:

1. It raises the amount financed above the new car's price, so the new loan starts underwater on day one.
2. You pay interest on it for the full new term — old debt, new rate, longer schedule.
3. It usually pushes you toward a longer term to keep the payment tolerable, which extends the period you are underwater.

This is the mechanism by which one underwater car becomes two. The calculator lets the trade-in value go negative for exactly this reason — it is a real and common position, and pretending trade equity is always positive hides the most expensive thing many buyers do.

If you are in this position, the cheapest move is usually to keep the current car until the loan and the value cross, rather than rolling the gap forward.

The costs that turn up after the purchase

• Insurance, which varies far more by model than most buyers expect. Get a quote on the specific car before buying, not after.
• Registration and taxes, annual in many states and scaling with value.
• Fuel, which depends on the car as much as on the miles.
• Maintenance, which is not zero even on a new car and rises steadily.
• Tires, which are a real four-figure event on larger vehicles.

Estimate all of these and add them to the payment before comparing against 10% of gross.

What to ask

1. What is 10% of my gross monthly income? That is the all-in budget.
2. What do insurance, fuel and maintenance cost on this specific car? Subtract those, and what is left is the payment you can afford.
3. What term does that imply? If the answer is over 60 months, the honest conclusion is that the car is too expensive, not that the term should be longer.
4. What is my trade actually worth, and what do I still owe? Get both numbers before you go in.
5. Can I put 20% down? If not, you are choosing a period of negative equity. That may be fine; it should be a choice.

A lender's maximum is a statement about the loan. The 20/4/10 rule is a statement about your life. Shop the total price of the car, never the monthly payment — the payment can be made to say almost anything.

Sources: 20/4/10 is a widely used planning rule of thumb rather than a lending standard — the lender-maximum figures come from ordinary auto underwriting on income and existing debt, which is a different test, and the calculator shows both. Depreciation and negative-equity behaviour is covered in how fast a car loses value, whose figures are computed with this site's own amortization.