How Much Car Can I Afford? (20/4/10 Rule)

Unknown Speaker 0:02
This is the digital nomad quest podcast, Sharon Tseung. teaching people how to build passive income become financially free and design their best lives.

Unknown Speaker 0:14
Hey guys, Jaron from digital nomad quest, and today we’re gonna talk about how much car you can afford, and we’re gonna hone in on the 2410 rule. Now, as you guys might know, already, cars are depreciating assets. So once you drive a new car out of the lot, it’s going to decline in value. According to lending tree, a car can lose up to 20% of its value in the first year and over the first five years fall to around 40% from the original price, that means it loses about 15% of the value each year after the first year. That’s why I actually bought a used car, it’s a 2012 red Nissan Sentra, got it on Craigslist, and it runs great, and it’s pretty safe. I love it. Because I didn’t pay a ton of money, I’m not paying extra in interest for something that’s losing value over time. So that’s why I do recommend doing the same route. So you don’t have an extra expensive monthly expense. Now, if you don’t have enough to buy all cash, you might consider getting a loan. And that’s why we’re going to go over this 2410 rule to kind of understand what is more appropriate, because you don’t want to get a loan where it cuts into most of your monthly income and you’re not saving or investing any of it. So if you can’t pay in full and you’re not sure how much car you can afford, this is the video for you. So you guys might be wondering what is the 2410 rule. So let’s start off with a 20. In this rule, it basically means a 20% down payment minimum, it’s recommended to put at least this much so you can reduce your interest as much as you can. If you’re doing 0% down, you’re likely to pay a lot in interest. So if your car is $24,000, then your downpayment should be at least $4,800. Because $4,800 is 20% of that 24,000. If you can’t make that downpayment, you should probably get a cheaper car, your car financing is also likely to be approved faster if you do this because you are putting in deposit which is some assurance that you have some money to put down for this loan. Now let’s move on to the fourth and the 2410 rule, the floor refers to the maximum term of the loan. So here it means four years, which is 48 months, you basically want to keep it for years or less, because it’s gonna save you money in the long run, lowering your monthly payments and allowing you to own the car sooner. So Consumer Reports says that the average life expectancy of a new vehicle these days is around eight years or 150,000 miles. So the lifespan is around eight years, it’s kind of like you’re paying for half of its lifespan and keeping the loan payments short also means that you’re not tying yourself to the car in case you want to sell it in the future. So that’s why if you do sell it after four years, you’d possibly get a more reasonable price than if it were eight years as long as it’s in decent condition. And then again, if your loan term is shorter, you’re likely to pay less in interest. Now let’s move on to the 10. And the 2410 rule, the 10 refers to 10% of your total monthly income. And that’s basically the max you should be paying every month for this. And that includes the car loan, the principal interest, but also the gas, the maintenance costs and things like that, that 10% Max is basically what you’re paying every single month for this car. Because if you’re paying more than 10% of your monthly income, that is kind of a red flag, you are saving a lot less money because that’s not even considering like your rents, living costs and things like that. This is just for your transportation. So you want to make sure you reduce those payments as much as you can. And you also have no idea what’s going to happen in life. If there are emergencies and you’re paying most of your money monthly to this car loan, you will have a lot less to keep yourself safe in case of emergencies. So as a tip, you always want to make sure you have emergency funds, experts usually recommend around three to six months of expenses saved up just in case. So now let’s ask how much car can I afford? Let’s go over a few examples here. So let’s say this guy, Tom makes $50,000 a year that’s going to be $4,166.67 per month 10% of our monthly income would be foreign to $16.67. Now he wants to buy a car at $24,000. So first scenario is he doesn’t follow that 2410 rule and then let’s go over what terms he’s going to use. He decides you know what, I’m not going to put down a down payment. Let’s just do 0% down. And then according to experience state of the automotive finance market report for the first quarter of 2020 to the average auto loan interest rate is 4.07% for new cars and 8.62% for used car, so let’s use that 4.07% For the interest rate. He also asked to pay for the car for 60 months, which is five years instead of the four years we recommend it it’s given the numbers so the loan amount would be $24,000. Since he’s doing a 0% down payment, the interest rate will be 4.07%. So then the interest he’s paying after 60 months is $2,565.30. That means the total amount he’s paying including principal and interest is $26,535.30. His monthly payments for this for 60 months is formed.

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$42.76 The next scenario is he decides to follow that 2410 rule. So instead of doing 0%, down, he’s gonna do a 20% down payment. Now in scenario two, Tom decides to follow that 2410 rule, but he actually decides, you know what, I’m gonna buy a cheaper car, let’s do a $20,000 car instead, just to make sure that he’s going to be able to pay off those monthly payments without exceeding that 10%. So this time, Tom puts out $4,000 for the down payment, which is 20% of $20,000. And then he’s gonna end up financing only $16,000. So in comparison with the first scenario, he is financing a lot less money, he’s going to follow that for years in the rule. So that’s 48 months. So let’s go back into the numbers total loan amount is $16,000, the interest he’s gonna pay after 48 months will be 13 $64.78. This brings them now you’re gonna pay total for principal and interest to $17,364.78. Because he followed that rule, his monthly payment is going to be a lot lower at 48 months, he’s going to be paying $361.77 per month, in the first scenario, he was exceeding 10% of his monthly income, he is paying about $26 more per month now in this new scenario, he was paying about $50 less per month at that $361. So that’s a lot better than the first scenario. So the idea is you want to pay less and monthly payments, you want to have lower interest, because you don’t want to pay extra for this car, and you want to shorten that term. So he did a lot better in Scenario two financially. Now, again, that 2410 rule is just a recommendation is just a basic framework to help you think about your car purchases. But again, I really recommend doing all cash. So let’s talk about another scenario that might make sense for you. So let’s say you already have that $4,000 for a down payment, maybe you can use that money and buy a car used all cash. Now granted, right now use cars cost a ton of money almost as much as new cars. But essentially, if you’re able to pay $4,000, for a used car that’s decently safe, let’s just talk hypothetically, right? Like my car was about $6,700. So it’s kind of close to that $4,000 number, and I probably could have gotten something cheaper. So maybe you find something on Craigslist, or on a Facebook group, just make sure that whatever you buy has to run safely. That’s what I care about most with these car purchases, you gotta make sure you’re buying something that actually runs well and is safe. But if you do find something at 4000, for example, like in this scenario, he has enough money with that 4000, if you can buy a used car for that price is going to totally change his financial future. Because let’s talk numbers, let’s see what this looks like. So instead of paying that $361.77 per month for this car, you’d be able to save that money instead. So let’s say he puts 32 $61.77 Every month into a bank account in two years, that’s going to amount to $8,682.48. And then in five years, it’s actually going to become $21,706.20. By then you’d be able to buy a new car all cash if you really, really wanted to. But instead, let’s say you invest that money, let’s say you invested it in ETFs, or index funds and get about a 7% return. As you can see here in five years, it’s gonna become $24,912.20. The more you contribute, the more Compound Interest can work for you. And basically, compound interest is the interest you’re going to earn on interest, it all adds up over time. So for example, if you put $100 in the bank, you’re gonna get 7% interest on $107 The next year instead of just $100. So that’s why it adds up dramatically if you can invest more and more. So if you compare the three scenarios, the first two, you’re getting a loan for a car, you’re paying monthly on it. And then the third scenario, you’re taking that monthly payment and saving it and investing it you would end up with almost $25,000 in the bank after five gears while in the other scenarios, you would end up with a depreciating asset essentially, and none of those funds saved up now if you can’t afford to buy a used car at the moment. Maybe it’s advantageous to save up carpool or bike to wherever you need, go live at home. Whatever you can do to scrounge up more fun, I would also say get more part time positions start freelancing start working on your side hustles how to build passive income because the more you can save and invest at an earlier age, the faster can compound people always say this right? If you start earlier, you can build your financial future up that money is going to work for you so that you can spend it on a car later on down the road and not have to live paycheck to paycheck you’ll have returns from your investments covering your monthly payments if you really wanted to get a car loan later down the line. That’s why if you did want to buy a nicer car in the future, it would make sense to practice delayed gratification, save up invest, then be able to really afford that nicer car later down the road. To me, I don’t really care about luxury cars. I don’t care about driving anything expensive because I’m the type that is

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A little bit more careless. So I wouldn’t be worried about getting scratches on the car or getting dents on it. I just prefer being a little bit more stress free, less things to think about. I care more about time and freedom. But I know there are a lot of car enthusiasts out there. I don’t judge because people have different values. If you’re passionate about your cars go for it. I’m not judging if you want to get a nicer car, because for me, I value experiences. I love creating music, so I’ll spend more money on those types of things. This 2410 rule is basically just helping you guide you financially so that you can afford these luxuries now, hope you guys enjoyed this episode. You know, buying a car can be one of the biggest purchases you’re gonna make. So you want to do it wisely. And I know it can be kind of confusing trying to figure out what are the best financing terms for this, I really hope that this helps guide you in your decision process. I think the 2410 rule definitely simplifies it and take some of that stress out of that car shopping experience. So again, as a recap, minimum 20% Down payment if possible four year loan term at max and then Max 10% of your monthly income spent on your car loan on your gas insurance, repairs and everything like that. But ultimately make sure that you’re buying something say that’s what really matters the most. So I hope you guys enjoyed this episode, please make sure to rate review and subscribe. It really helps our podcast grow. And thanks again. I’ll see you guys in the next one.

Transcribed by https://otter.ai