When you decide the time is right to buy a car, you are bound to ask yourself how much of a down payment you should make, or if you should make a down payment at all. The numbers can be confusing – is it better to keep the cash and have higher monthly payments, or should you make a higher down payment and reduce your monthly payments?
In this article, we'll discuss what down payments are, how they affect your financing options, and how to decide what’s right for you. Let's take a look.
Everything you need to know about down payments
How do down payments work on cars?
A down payment is money you pay upfront for the car you are buying. It is essentially your first payment on your new car. Most of the time, lenders require down payments, but even if it is not a requirement, it might be a good idea.
How much should I put as a down payment on a car?
Experts agree that on a new car you should put down at least 20% of the car’s purchase price. If you don’t have the best credit, increasing this might give you better chances of scoring better terms. If you are purchasing a used car, experts recommend a 10% down payment. Since used car loan rates are usually higher than new car rates, a higher down payment will save you more money with a used car.
Does a large car down payment offset bad credit?
Yes and no. A larger down payment will certainly make you a more desirable candidate, but lenders will always look at your credit score when deciding whether or not to finance your car. Ultimately you want to stay on top of your credit and work to improve your score.
A great way to improve your credit score is to refinance any existing car loans you may have. Refinancing to a lower APR can make your payments more manageable and improve your score quickly. A quote from Auto Approve takes only a few moments and can help you decide if refinancing is a good option for you.
What are the benefits of putting a down payment on a car?
There are many benefits to putting a down payment on a car. Not only is it required in most cases, but it will most likely save you money in the long term.
You will pay less interest and your monthly payments will be lower
Making a down payment will lower the balance of your loan overall, and in turn save you money on interest. Let’s look at the following example.
You would like to buy a new car with a purchase price of $25,000 and you choose to not make a down payment. You have an APR of 5% and a sales tax of 6%, and you have decided on a 48 month payment period.
Total Loan= Purchase Price + Sales Tax
Total Loan= $25,000 + .06 x $25,000
Total Loan= $26,500
Over the life of the loan, you will pay $2793 in interest on this balance of $26,500, ultimately paying a total of $29,293 on your $25,000 car. Your monthly payments will be about $610 per month.
Now let’s look at what happens when you put a 20% down payment on a car.
Total Loan= Purchase Price + Sales Tax - Down Payment
Total Loan= $25,000 + .06 x $25,000 - $5,000
Total Loan= $21,500
Over the life of the loan, you will pay $2266 in interest on this balance of $21,500, ultimately paying a total of $23,766. Your monthly payments will be about $495.
Now let’s compare. In the first scenario, you are paying a total of $29,293 for your car. In the second scenario, you are paying $23,766 plus your $5,000 down payment, for a total of $28,766. By paying a down payment, you are saving $527.
Over the course of four years, it is doubtful that any easy investment you can make of $5,000 will yield a profit of $527, so a down payment is certainly the better option. Plus, your monthly payments will be lower so it will be a more manageable monthly payment over four years.
The approval process might be easier
Having the capital available to you to make a down payment is a good indication to lenders. It shows that you are in good enough financial standing to make a significant upfront payment and can lead to a better interest rate and better terms.
It might qualify you for special incentives
Dealerships often run promotions to encourage sales, and down payments are often conditions of these promotions. These incentives might include low APRs or rebate programs. Always be sure to read the fine print of these deals.
It can offset depreciation
Offsetting depreciation is another important reason to make a down payment. Cars tend to lose 15% of their value per year, but new cars depreciate even faster, losing about 25% of their value in the first year. If you do not make a down payment, you might risk being upside down in your loan. This means that you owe more on the car than the car is worth. This is never a situation that you want to end up in, so it is important to stay ahead of depreciation. If you are ever in a bind, this means that you will not be able to break even if you sell your car and pay off the loan. Making a down payment will get you ahead of depreciation quickly, especially the first year’s drastic depreciation.
How do you save for a down payment?
Now that we know how important down payments are, how can you save enough to make one?
Make a budget
This is one of the most important things you can do for your financial health. Determine all of your income and all of your expenses, and see how the numbers fall.
Set a goal
Creating a down payment goal will help you stay focused with your new budget. If your dream car is $30,000, you know that you should aim for a $6,000 down payment. It is important that you never sacrifice an emergency fund for your down payment. If something catastrophic comes up and you don’t have a buffer, it will have a ripple effect through your entire financial life. Make sure you keep a separate rainy day fund in addition to your down payment goal.
Cut spending where you can
Now that you have the numbers in front of you, you can see the areas where you may be overspending. Cutting things here and there will add up over time and result in big savings.
If you have an existing auto loan, refinancing is a great way to reduce your monthly payments and free up money in your budget. Refinancing to a lower rate can save you hundreds of dollars a month – and Auto Approve can help you get the ball rolling and start saving today.
Keep focused on your goal
Staying on track with your budget is important if you are serious about saving for a down payment. For more information on creating a budget, you can read our guide on budgeting or pick up one of these books on personal finance.
What if you can’t make a down payment?
If making a down payment just isn't in the cards for you, hope is not lost. If you have a good credit score you can still get approved and get a decent APR, but it will probably not be as good as if you did have a down payment. You should shop around for loans ahead of car shopping to see what types of deals you can get without a down payment.
What about the advertisements for a zero down deal?
You will sometimes see advertisements for financing with zero down payment required. This is not necessarily a bad idea, but if you do not have good credit be prepared for less than ideal terms. This may lead to high interest rates and can cause you to become upside down in your loan. Be sure to read all the fine print and know what you are getting into before you sign on the dotted line.
That’s everything you need to know about down payments and why they are so important.
The bottom line is a down payment will usually help you save money in the long term and protect you from depreciation. If you are able to save for a down payment, it will help you secure better rates as well.
If you have an existing auto loan, be sure to check on your rate and terms. You could be overpaying by hundreds of dollars every month. If that’s the case, Auto Approve is here to help you secure a better rate. We love saving people money, and it could be just what you need to save for that down payment.