By Balachandran Viswambharam
Have you always dreamed of owning a particular car or bike? For many people, the fascination with vehicles begins in childhood or the teenage years. Pictures of their dream car or bike may find a place on the bedroom wall, laptop screen or phone wallpaper.
There is nothing wrong with such dreams. In fact, having a clear goal can be a powerful motivator. A child who thinks, “I need to study well, get a good job and earn a good salary so that I can buy my dream vehicle,” is already learning the value of setting goals.
The dream vehicle may change as the years go by. The car that seemed irresistible at 15 may no longer appeal at 25. Or the person may realise that the vehicle costs more than they can comfortably afford.
That is perfectly normal. Priorities change as life moves on.
But if owning a vehicle remains a dream, there is no need to give it up. With some financial discipline, you can work towards it without putting unnecessary pressure on your finances.
Here is a simple rule to follow when buying a car:
Pay 20 percent of the car's price as the down payment.
Keep the loan tenure to five years.
Ensure that the EMI does not exceed 20 percent of your monthly income.
There are two ways to use this rule:
Top-down approach: Decide which car you want and then check whether you can afford it.
Bottom-up approach: Start with your income and calculate the maximum car price you can afford.
Suppose you have decided to buy a Hyundai Creta with an on-road price of Rs 24 lakh.
Under the 20:5:20 rule:
Down payment: 20 percent of Rs 24 lakh = Rs 4.8 lakh
Loan required: Rs 24 lakh - Rs 4.8 lakh = Rs 19.2 lakh
Loan tenure: Five years
Assuming an interest rate of 8 percent, the EMI would be around Rs 39,000 a month.
For this EMI to remain within 20 percent of your monthly income, you would need a monthly income of roughly Rs 1.95 lakh.
That translates to an annual income of about Rs 23.4 lakh.
So, under these assumptions, the Rs 24 lakh Creta would be affordable only if your monthly income is around Rs 1.95 lakh or more.
The actual EMI will vary depending on the interest rate, loan amount and lender.
The bottom-up approach reverses the calculation. Instead of starting with the car you want, you start with your income and determine what you can afford.
Suppose your monthly income is Rs 3 lakh, giving you an annual income of Rs 36 lakh.
Under the 20:5:20 rule, your car EMI should not exceed 20 percent of your monthly income.
Maximum EMI: Rs 3 lakh × 20 percent = Rs 60,000
Loan tenure: Five years
At an assumed interest rate of 8 percent, an EMI of Rs 60,000 would support a loan of roughly Rs 29.5 lakh.
If the down payment is 20 percent of the total car price, the loan represents 80 percent of the purchase price. Therefore:
Loan amount: Rs 29.5 lakh
Estimated down payment: Rs 7.37 lakh
Maximum car price: About Rs 36.87 lakh
This means someone earning Rs 3 lakh a month could consider a car costing around Rs 37 lakh or less, subject to the interest rate and other financial commitments. Vehicles in this price range could include models such as the Toyota Innova Crysta.
The 20:5:20 rule works like a financial palindrome: whether you start from the car price and work down to your income or start with your income and work up to the car price, you arrive at broadly the same affordability framework.
It can therefore take some of the emotion out of what is often a highly emotional purchase.
If your car EMI exceeds 20 percent of your monthly income, the purchase could put considerable pressure on your finances. The strain may not be obvious initially, but could become a problem later.
There is another factor to consider: a car is a depreciating asset. Its value generally falls over time. Even if you sell the vehicle later, the resale value may not fully compensate for the money you have spent on it, including interest and other ownership costs.
Buying a car is rarely just a financial decision. For many people, it represents achievement, independence and the fulfilment of a long-held dream.
There is nothing wrong with enjoying that achievement. But the dream should fit within your financial capacity.
The 20:5:20 rule provides a simple starting point. Before booking your next car, calculate the down payment you can make, the EMI you can comfortably handle and the loan tenure you are willing to take.
A dream car is worth enjoying. It is not worth sacrificing your financial stability for.
