The 20/3/8 rule: One approach to buying a car

Quick insights

• Deciding which car to buy depends on your preferences and situation, but the 20/3/8 rule could help you make your choice.
• The rule recommends a 20% down payment, a three-year financing term and car expenses that equal 8% or less of your monthly income.
• To apply the 20/3/8 rule, you’ll need a firm grasp on your budget.

Navigating the auto market is a tall order unless you have your dream car in mind. Even then, however, the up-front and long-term costs of buying a car are important to understand before you make a choice.

One way you could narrow your car search and prepare for ownership is by applying the 20/3/8 rule.

What is the 20/3/8 car-buying rule?

The 20/3/8 car-buying “rule” is more like a financial guideline, and it will help you assess your purchasing power. The rule addresses three components of car-buying: the (20%) down payment, (three-year) loan term and (8% of) your monthly budget. Following the rule could help you avoid a car purchase that overextends you financially.

Breaking down the 20/3/8 rule

Each figure in the 20/3/8 rule has a specific purpose in helping you prepare to buy a car.

Putting 20% down

A minimum down payment of 20% for large purchases, including cars, often has several benefits. The down payment reduces the principal loan amount and the interest you’re likely to pay, regardless of the interest rate. The lower principal created by the down payment translates to a lower monthly payment.

Financing for three years

Three years is a relatively short term for an auto loan. Generally speaking, the longer the loan term, the more you will pay in interest. You can save money in interest because a three-year term will accrue less interest than longer loan terms.

Planning for 8% total transportation costs

Ensuring monthly vehicle expenses do not exceed 8% of monthly income relies on how much you spent on your car, how much you drive and spend on gas, the insurance rates assigned to your neighborhood, etc. To keep your costs within 8%, you may have to plan on a less expensive car, drive less and shop around for the best insurance rate you can find.

Benefits of following the 20/3/8 rule

• Lower interest costs: Loans accrue less interest the shorter they are, regardless of the interest rate.
• Budget control: Keeping your car payment and expenses within 8% of your monthly income can help you maintain your overall budget. The monthly target could also ensure money is available for other needs and wants.

Downsides of the 20/3/8 rule

• Higher monthly payments: A three-year loan term has 36 monthly payments. The interest rate and principal are also important, but a lower number of payments usually results in a higher amount due each month. If you chose five year financing, your monthly payment would be less, but you’d pay more interest over that time. Succeeding with the 20/3/8 rule relies on your willingness and ability to make every monthly payment on time.
• Stricter budget could limit options: The 20/3/8 rule creates specific targets for the down payment and monthly costs of buying a car. These numbers affect your budget and can narrow which cars are affordable.

How does the 20/3/8 rule compare with the 20/4/10 car-buying rule?

The 20/4/10 and 20/3/8 rules for car buying are very similar. For the 20/4/10 rule, the “20” still corresponds to a 20% down payment. However, the 20/4/10 suggests that you apply for a four-year loan term and budget for 10% of your monthly income to your car expenses.

The first key difference is the loan term: Assuming the vehicle price, down payment and interest rate are the same, a four-year loan term would have lower monthly payments than a three-year term. The other key difference is targeting 8% instead of 10% for your monthly transportation costs. The numerical differences may seem small but could create real financial value.

Applying the 20/3/8 rule

To apply the 20/3/8 car-buying rule and determine your purchasing power, here are the steps you can take:

• 20% down payment: You’ll need this up front when you buy a car, so aim to save it up or have it ready to pay at the point of purchase. The car’s price minus your 20% will give you the loan amount, which will be spread over the loan term and accrue interest.  
• Three-year loan term: This creates 36 equal monthly payments based on loan amount and interest rate. You’ll pay less interest overall, even though the monthly payments will be higher.
• 8% of your income: This dollar amount is your goal for the monthly car payment and other potential costs of driving and maintaining your car. When trying to arrive at this goal with different cars at different prices, you might want to experiment with a car payment calculator.

In conclusion

The 20/3/8 rule is a guideline that suggests you put 20% down on a car and repay the loan over three years. Applying the rule correctly will also require your monthly payment and car expenses be 8% or less of your income.

Taking a moment to assess your financial situation and prepare a realistic budget can go a long way in helping you plan for an affordable car purchase. The 20/3/8 rule is one way you can make an informed choice that works for you.