This article discusses the aspiration of owning a car, particularly for teenagers, and acknowledges that life priorities can shift, potentially leading to a need for a more practical vehicle than initially envisioned. To navigate this, the author proposes a financial guideline called the "20:5:20 rule," which suggests a 20 percent down payment, a 5-year loan term, and the Equated Monthly Installment (EMI) not exceeding 20 percent of one's monthly income. The rule can be applied using a "top-down" approach, starting with the desired car and calculating income requirements, or a "bottom-up" approach, beginning with income to determine an affordable car. Adhering to this rule aims to prevent financial strain and regret by ensuring the car purchase is manageable within one's financial means, highlighting that while car buying is emotional, financial feasibility is crucial for a sensible decision.

This article discusses the aspiration of owning a car, particularly for teenagers, and acknowledges that life priorities can shift, potentially leading to a need for a more practical vehicle than initially envisioned. To navigate this, the author proposes a financial guideline called the "20:5:20 rule," which suggests a 20 percent down payment, a 5-year loan term, and the Equated Monthly Installment (EMI) not exceeding 20 percent of one's monthly income. The rule can be applied using a "top-down" approach, starting with the desired car and calculating income requirements, or a "bottom-up" approach, beginning with income to determine an affordable car. Adhering to this rule aims to prevent financial strain and regret by ensuring the car purchase is manageable within one's financial means, highlighting that while car buying is emotional, financial feasibility is crucial for a sensible decision.

This article discusses the aspiration of owning a car, particularly for teenagers, and acknowledges that life priorities can shift, potentially leading to a need for a more practical vehicle than initially envisioned. To navigate this, the author proposes a financial guideline called the "20:5:20 rule," which suggests a 20 percent down payment, a 5-year loan term, and the Equated Monthly Installment (EMI) not exceeding 20 percent of one's monthly income. The rule can be applied using a "top-down" approach, starting with the desired car and calculating income requirements, or a "bottom-up" approach, beginning with income to determine an affordable car. Adhering to this rule aims to prevent financial strain and regret by ensuring the car purchase is manageable within one's financial means, highlighting that while car buying is emotional, financial feasibility is crucial for a sensible decision.

There is no dream sweeter than owning a car. In fact, it is one of the craziest dreams you could have as a teenager. If you walk into any of these teenager’s bedroom, you could see their dream car poster stuck up on the wall.

Having an addiction to cars and bikes is much better than other substances and behaviours, because this one will give them a higher purpose and make them study better.

If your kids are teenagers, encourage them to post images of their favourite bike or car on the wall.

Many years later, the car they buy could be totally different than the dream they had. Either the interest in the car would have changed, or the job they took might not be enough to afford it.

This is perfectly normal, as life’s other priorities may catch up and you may have to settle for a car that's more utilitarian.

Just because other priorities have caught up with you does not mean you need to give up entirely. There could still be a way to make it work. Use my 20:5:20 rule to check whether the car is affordable; if so, go for it.

The 20:5:20 rule goes like this:

  1. 20 per cent down payment.
  2. 5-year loan.
  3. 20 per cent of your monthly income as EMI.

There are two ways to approach this rule

  1. Top down
  2. Bottom up

The top-down approach begins by identifying the car, then calculating the finances. For example, if the on-road price of Hyundai Creta is 24 lakhs, then the rule works out to be:-

  1. 20% down payment, i.e 20 per cent of ₹24L = ₹4.8L
  2. 5-year loan on ₹19.2L (24–4.8, i.e. total amount minus down payment). I am assuming it at an 8% rate, then the EMI works out to be: ₹38,930
  3. The EMI of ₹38,930 should be 20 per cent of your monthly income. Hence, your monthly income should be in excess of ₹38,930/20% = ₹1.95L

You need a monthly income of at least 1.95L, or an annual income of 23.4L to afford this car.

The bottom-up approach begins by calculating your monthly income and then determining what car you could afford. For example, your monthly income is ₹3L (annual income ₹36L)

  1. EMI should be less than 20% of ₹3L, i.e. ₹60,000
  2. The 5-year loan amount could be approximately ₹29.5L at 8 per cent if you are ready to pay a ₹60,000 EMI.
  3. The 20% down payment required would be: ₹7.37L (₹29.5L/4)

The maximum value of the car you could buy would be ₹29.5L + ₹7.37L = ₹36.87L. You could think about buying a Toyota Innova Crysta, for instance.

The 20:5:20 rule is a palindrome, meaning you could use either the top-down or bottom-up approach and still get the same results. This engineered rule will ease stress and zero in on the best car you could afford based on your current income.

If the current EMI is way above 20 per cent of your income, it could cause financial stress, and sooner or later, you might regret purchasing that car. This is because a car depreciates in value over time, so even if you trade it in, it would not fill the financial void it created.

I know buying a car is more of an emotional decision than just a financial one. But since you learned the 20:5:20 rule and were able to fit your car purchase into this formula, the final outcome will be sensible.

The writer is a SEBI Registered Investment Adviser (INA000021757), SEBI Registered Research Analyst (INH000025045), and author of ‘How to join the top 1% options traders club’.

DISCLAIMER: Investments in the securities market are subject to market risks, including the potential loss of principal. Past performance does not guarantee future results. Information provided is for educational purposes only and should not be considered financial advice. Investors should read all related documents carefully and consult a certified advisor before investing. Registration granted by SEBI and Enlistment with RAASB/BSE and certification from NISM in no way guarantee the performance of the intermediary or provide any assurance of returns to investors. The investor is requested to take into consideration all the risk factors before actually trading in stocks or derivatives.

The opinions expressed in this article are those of the author and do not purport to reflect the opinions or views of THE WEEK.

TAGS