The 20/4/10 rule, tested

That is the 20/4/10 rule as it usually circulates. Versions differ on the last number: some count only the loan payment and insurance against the 10 percent, others fold in fuel and maintenance too. We used the more forgiving version — payment plus insurance — because if a household fails the lenient reading, it fails the strict one as well.

Test conditions, all illustrative: every household puts exactly 20 percent down and borrows the rest over 48 months at 7.0 percent APR. That rate is an assumption for arithmetic, not a quote; yours depends on your credit and your lender. At those terms, each $1,000 borrowed costs about $23.95 a month. Insurance figures are made-up quotes for each household. Taxes and fees are ignored to keep the comparison clean.

For each household we worked backward from the rule: 10 percent of monthly gross income, minus insurance, leaves the room for a payment. That payment, over 48 months at 7 percent, supports a certain loan. Divide that loan by 0.8 and you have the most expensive car the rule allows. Then we set it beside the car each household was actually looking at.

Grading was mechanical: pass at 10 percent or under, strain from just over 10 up to 12.5 percent, fail above that. To check one row by hand: household C would borrow 80 percent of $38,000, which is $30,400. At $23.95 per thousand that is a payment of about $727.97; add the $210 insurance quote and you reach $937.97, which is 15.6 percent of their $6,000 monthly gross.

What the five results teach

Two passes, one strain, two fails. The tempting conclusion is that three households are overreaching. Some of them are. But the rule also fails in ways that have nothing to do with the households, and those are the more interesting results.

• APassing is not the same as being fine.

  A clears the bar with room to spare, and the rule would let them spend another $4,454. But 10 percent of gross income is a large sum at $110,000, and the rule says nothing about fuel, parking, repairs, or the second car this household almost certainly also runs. A generous income makes a percentage rule loose. The pass tells A that the payment fits; it does not tell them the car does.

• BA strain is a negotiation, not a verdict.

  B is $4,078 over the rule's ceiling. That gap is small enough to close with a larger down payment, a cheaper trim, or a slightly older model — or to accept knowingly, if B has no other debt and walks to most places. Strains are where the rule is most useful: it names a specific number to argue with.

• CThe rule doesn't know how many seats you need.

  C is not shopping for a luxury car; they're shopping for something that fits two children and a stroller. The rule's answer, about $20,000, is still a real answer — it points at a used version of the same vehicle — but the failure here is a sign of a single-income household carrying a family-sized need. The fix probably isn't in the car at all. It's in the rest of the budget, or in the length of time they keep whatever they buy.

• DAt low incomes, the rule can price you into older cars with their own costs.

  After insurance, D has $160 a month of room, which supports a car of about $8,352. The rule is telling D something true: a $22,000 car costs more than this income comfortably carries. But a car at the rule's price may bring repair bills the rule never counts. The honest reading is that D's binding constraint is insurance, which eats more than half the allowance. Shopping the policy, or choosing a car that is cheaper to insure, moves D's number more than haggling over the car would.

• EThe rule measures today's income.

  E passes, narrowly, on a salary that ends in five years. A four-year loan finishes before retirement, which is the one thing E has done exactly right. Had E stretched to six years to buy more car, the last payments would land on a retirement budget the 10 percent test never saw. Rules built on current income say nothing about next year's.

How to use it anyway

Run the rule in reverse, as we did: start from your income, subtract your own insurance quote, and let the arithmetic tell you a price. Treat that price as the start of a conversation. If your result says pass, check what the rule leaves out — fuel, maintenance, parking, the annual bills — before you spend the headroom. If it says strain, look for the single change that closes the gap. If it says fail, look at the whole budget before you look at a longer loan, because stretching the term is how people make a failing number look like a passing one.

Of the three legs, the four-year limit does the quietest work. It keeps the loan from outlasting the car's easiest years and keeps interest from compounding over a long tail; the same loan at five different terms shows how quickly that tail grows. For a different angle on the 10 percent, how much of your income a car payment should take lays several percentages side by side at a few incomes.

The rule survived the test, in the end, but not as a rule. It works as a fast first estimate, useful precisely because it's crude. The households that failed it learned the most.