In this article
Quick summary
- Put at least 20% down so the loan, and the interest on it, stays small.
- Aim to repay within four years, five at most. A car loses value faster than a loan shrinks.
- Keep what the car costs you every month, EMI plus running costs, near a tenth of your income.
The showroom is designed to make you say yes. The new-car smell, the test drive, the “easy EMI” offer on the board. What it doesn’t show is the price you pay for stretching: a car that is worth less every year while the loan lingers on, and a budget with no room left for anything else.
Personal finance has a simple rule of thumb to keep you honest. It is called the 20/4/10 rule. It isn’t a law, and it was made for a different country, so you may need to bend it. But as a starting point, it is hard to beat.
The rule in one line
| Number | What it means |
|---|---|
| 20 | Put down at least 20% of the car’s on-road price |
| 4 | Repay the loan in four years or less (five at the outside) |
| 10 | Keep the car’s total monthly cost at around 10% of your gross income |
Why 20% down
A new car loses a good part of its value the moment it leaves the showroom, and more in the first year or two. If you borrow the full price, you can owe more than the car is worth. A solid down payment makes the gap smaller, protects you if you want to sell early, and shrinks the loan and the interest on it.
On a car with an on-road price of ₹10 lakh, 20% down is ₹2,00,000, and you borrow ₹8,00,000. Remember to use the on-road price, which includes registration, insurance and other charges, and not the ex-showroom price on the brochure.
Why four years
Long loans make the EMI look small and cost far more. Here is the same ₹8,00,000 at an assumed 9.5% a year, repaid over four years and over seven.
| 4 years | 7 years | |
|---|---|---|
| Monthly EMI | ₹20,099 | ₹13,075 |
| Total interest | ₹1,64,728 | ₹2,98,316 |
| You repay in all | ₹9,64,728 | ₹10,98,316 |
The seven-year loan is ₹7,023 a month easier, and costs ₹1,33,587 more in interest. By year six, the car is old, repairs begin, and you are still paying for it. If the shorter EMI doesn’t fit, that is a sign the car is above your budget, not a reason to stretch the loan.
Why 10% of income
A car costs more than its EMI. Add fuel, insurance, servicing, tyres, parking, tolls and the odd repair. The rule asks you to keep all of that together near a tenth of your gross monthly income, so the car doesn’t crowd out savings and other goals.
Using the same car, say the running costs are ₹8,000 a month. With the four-year EMI of ₹20,099, your monthly car cost is ₹28,099. Under the strict rule, that points to a gross income of about ₹2,80,985 a month. That is a lot, and it tells you something honest: a ₹10 lakh car is a stretch for most households.
Is the car worth borrowing for at all?
A car is a cost, not an investment. It earns nothing and loses value each year. That is fine, as long as it is a cost you can carry. Ask yourself: do I need it for work or family, or do I want it? Could a smaller or a good used car do the job? The gap between a car you can afford and a car you want is where most car loan regrets come from.
Before you sign the loan
- Compare the on-road price. Ask the dealer to break down insurance, registration and accessories. Some are optional.
- Check what is added to the loan. Insurance, extended warranty and accessories can be rolled into the loan, which raises the amount and the interest.
- Compare the dealer’s offer with a bank’s. They can differ in rate and fees. Ask for the all-in cost of each, not just the EMI.
- Read the key facts statement. It shows the full yearly cost, called the APR, with all charges, and the total you will repay.
- Ask about closing early. Car loans are often fixed-rate and can carry a charge for closing early. Ask what it is, and after how many EMIs you can do it.
- Understand hypothecation. The lender’s name goes on your registration certificate until the loan is repaid. After repayment, ask for the no-objection letter and have the record removed.
New car or used car?
| New car | Used car | |
|---|---|---|
| Price | Higher | Lower |
| Loss in value | Highest in the first years | Slower, since the steepest drop is behind it |
| Loan rate | Usually lower | Often higher, and loan tenures shorter |
| Warranty | Full manufacturer warranty | Limited or none |
| Hidden risks | Few | Condition, past accidents, papers; get an inspection |
Mistakes to avoid
- Shopping by the EMI: “What’s the monthly?” Ask for the total cost.
- Taking a long tenure to afford a more expensive car.
- Forgetting insurance, fuel and servicing in the budget.
- Using up your emergency fund for the down payment.
- Taking dealer finance without comparing it with a bank’s offer.
The bottom line
Use 20/4/10 as a test. If the car you want passes it, buy it with a clear head. If it fails, you have learned something useful for the price of a few minutes: this car is more than your budget wants. Choose a smaller one, a used one, or wait a year and save a bigger down payment. If you would like to compare car loan offers from several banks before you visit the showroom, we can do that for you.
Questions readers ask
Lenders often finance a large share of the on-road price for new cars, but it varies by lender, car and your profile. A higher down payment lowers the loan and the interest, and can improve your approval chances.
If you can pay in cash without draining your emergency fund, you save all the interest. If paying in cash would leave you with no cushion, a short loan is safer. Avoid using money you may need soon.
Usually yes, but car loans are often fixed-rate and may carry a charge for closing early. Ask for the exact charge and the earliest date you can do it, and get it in writing.
Shorter is cheaper. Four years is a good target, and five at most. A longer tenure lowers the EMI but increases the interest and leaves you paying when the car is old.
Yes. A car loan EMI counts against your income when a lender works out how much home loan you can get, so it lowers the amount. If you plan a home loan soon, think twice about a big car loan first.
