Why the 20/3/8 Car Buying Rule May Be Obsolete
The 20/3/8 car buying rule can be hard to follow when cars are expensive, so here's why it might not work for most car buyers.
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Article QuickTakes:
The 20/3/8 car buying rule says you should put 20% down, pay off your car loan in three years (36 months), and spend no more than 8% of your pretax income on car payments. As we go into depth to determine how realistic this rule is, you may consider whether it can actually help you budget for your next car.
What Is the 20/3/8 Car Buying Rule?
The Money Guy Show is a podcast hosted by financial planners Brian Preston and Bo Hanson. They popularized this rule as a variation on the 20/4/10 car buying rule. Since a car is typically a depreciating asset (one that loses value each year), this guideline is meant to avoid owing more than your car is worth or needing to purchase Guaranteed Asset Protection (GAP) insurance.
How the 20/3/8 Rule Works With Today's New Car Prices
The average price consumers paid for a new vehicle (including luxury vehicles) in April 2022 was around $47,000. Here's an example of how the 20/3/8 rule works with that purchase price.
Average new car = $47,000
A 20% down payment would be $9,400, leaving you to finance $37,600. With a 36-month loan term, here's what your monthly payment would look like at various annual percentage rates (APRs):
- 0% APR: $1,044
- 2% APR: $1,077
- 4% APR: $1,110
- 6% APR: $1,144
- 8% APR: $1,178
For those monthly payments to equate to 8% of your gross monthly income, you'd need to earn the respective amounts annually:
- 0% APR: $156,600
- 2% APR: $161,500
- 4% APR: $166,500
- 6% APR: $171,600
- 8% APR: $176,700
According to the Census Bureau in 2020, the U.S. median household income was just over $67,500, meaning that for a large percentage of the population this rule is impossible to apply, especially when shopping for new cars.
How the 20/3/8 Rule Works With Used Car Prices
Curious to know how this rule works with used cars? In early 2022, the median used car price was around $29,000. Using the same method as above, here's an example of how the 20/3/8 rule would work when purchasing the average used car.
Average used car = $29,000
A 20% down payment would be $5,800, leaving you to finance $23,200. With a 36-month loan term, here's what your monthly payment would look like at various APRs:
- 4% APR: $685
- 6% APR: $706
- 8% APR: $727
For those monthly payments to equate to 8% of your gross monthly income, you'd need to earn the respective amounts annually:
- 4% APR: $102,800
- 6% APR: $106,000
- 8% APR: $109,100
While the numbers in the used car example look better than the new car totals, the 20/3/8 car rule could be considered unreasonable by a large number of buyers somewhere near the median used car price.
Cheaper used car = $15,000
Since the median used car price is the average, there were quite a few sold under that number.
Looking at the numbers for a $15,000 used car yields a situation that could be more reasonable for some people. For example: with a down payment of 20% which totals $3,000, buyers would finance $12,000. Under a 36-month loan term, here's what your monthly payment would look like at various APRs:
- 4% APR: $354
- 6% APR: $365
- 8% APR: $376
For those monthly payments to equate to 8% of your gross monthly income, you'd need to earn the respective amounts annually:
- 4% APR: $53,100
- 6% APR: $54,750
- 8% APR: $56,400
0% Financing and the 20/3/8 Rule
Even if you qualify for 0% APR for 60 months, The Money Guy podcast still recommends paying off your loan in three years. The main concern is that if you stretch out a loan—even an interest-free loan—over too many years, you might spend more than makes sense for your budget. You may fixate on the monthly payment and brush aside the vehicle's overall cost. Plus, you could increase your chances of going underwater on your car loan.
Preston and Hanson, the podcast hosts, acknowledge that a longer loan term can give you more flexibility. Still, they encourage listeners to commit to paying off a financed car within 36 months (even if they accept a longer term).
Final Considerations
The 20/3/8 car buying rule can be challenging to adhere to without earning a specific income, especially when car prices are increasing. To make it work, most people will need to spend far less than the typical price for a new or used car.
If you want a newer car, choosing a longer loan term and paying for GAP insurance could potentially be a more fiscally responsible way to fit a car purchase into your budget. Still, it's ideal to choose a vehicle with a price tag that won't prevent you from saving for financial goals that will help you enjoy a stable future.
