Paycheck Chronicles

Do Your Car Expenses Meet The Rule?


Guidelines help make life a little more manageable.  Thankfully, they are everywhere.  You can find a guideline for just about anything.  Today, I want to talk about some guidelines for how much you should spend on transportation costs.  As with any guidelines, there are always going to be situations that fall outside.  However, if you're asking yourself, "How much should my car cost," guidelines can be super-helpful

This is a hot-button topic amongst personal finance folks who work with military families.  We've all see the Cameros and F150 Lariats and the Hummers on base.  No one is saying that you shouldn't buy a nice car if you enjoy them and you have the money, but rather that when you can't contribute anything to TSP and you have a $500 car payment, there might be something a little amiss.

The guideline I like for car buying is the 20-4-10 rule.  It has three parts.

20% Down

The first part of the rule says that you should never buy a car with less than 20% down payment.  Personally, I prefer that you pay cash or put down significantly more than 20%, but 20% is pretty much a bare minimum down payment to be sensible.  20% down keeps you from being underwater on your loan as soon as you drive off the lot, and it helps to keep your payment smaller.  We'll get to that part later.

4 Years

The second part of the rule says that you should finance your car for four years or less.  Again, I am more conservative.  I'd much rather you finance your car for two or three years, but four years isn't completely unreasonable.  Once a car loan gets beyond four years, you significantly increase the chances that:

  • your car's value will decline faster than your loan balance,
  • you vehicle needs will change, and/or
  • your car will start needing more expensive repairs and upkeep.

10% Transportation Expenses

The last part of the rule isn't just about a car loan, but rather about your total transportation expenses.  Your total transportation expenses, including the vehicle payment, registration, insurance, gasoline and maintenance should not exceed 10% of your total budget.  In my opinion, this is the most important part of the rule, and it is the hardest part to make happen.  Depending on your situation, you could spend almost 10% of your budget just on registration, insurance and gasoline - that doesn't leave a whole lot left for a loan payment and maintenance.

Let's say you are bringing home around $5,000 a month, including all allowance and deducting taxes and other things.  You spend $200 a month on gasoline to get back and forth to work, and $100 a month on insurance.  Registration in your state of legal residence is $60 per year.  Since you're already spending $305 a month on transportation expenses, your car loan PLUS maintenance funds should be $195 a month or less.  That's hard to do if you don't have a significant down payment.

Guidelines are meant to get you thinking.  Everyone has a reason why they can't fit in the guidelines.  Sometimes they are legitimate reasons, sometimes they're not.  Some honest self-assessment and thoughtful consideration can help you make the best decision for your situation, your happiness, and your financial health.

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