A down payment is known to be a percentage of the purchase price of the car. When you purchase a $30,000 car and make a 10% down payment, the down payment would be $3,000 at the time of sale. This down payment can be made in cash, by selling in your old vehicle or by a combination of both.
Lenders often want you to make a down payment to prove your commitment to repay the loan and get some upfront credit for the vehicle. As a general rule, aim at not less than 20% down, especially for new cars— and not less than 10% down for used cars— so that you don't end up paying too much for interest and financing costs.
Benefits of making a down payment may include a lower monthly payment and less interest paid over the life of the loan. Let's look at five reasons why putting cash down on your new vehicle makes a lot of sense — and what you can do if you can't make a down payment.
Pay Less Interest
The more cash you put in for a car, the less money you need to borrow for a vehicle. With a smaller loan you can pay interest on a lower balance, which ensures that your total interest rate will also be lower.
If you had a five-year $30,000 car loan with a 4.5% interest rate, you would have paid a total of $3,557.43 in interest. But with a 20% down payment ($6,000) on the same vehicle, you will pay just $2,845.95 in interest on that five-year loan— a saving of more than $711.
You can also get a lower interest rate with a down payment. That's because your loan-to-value ratio— the amount you borrow against the value of the car — is one factor that affects your interest rate.
Easily Getting Approved For A Loan
A down payment can help you to qualify for a car loan more easily, particularly if you have lower credit scores. Without a down payment, the lender will have more to lose if you don't repay the loan and they need to repay and sell the car. Cars can begin to lose value as soon as you're driving away.
Monthly Payments Can Be Lower
Making a down payment and reducing the amount you need to borrow can also reduce the amount of your monthly loan payment. Let's say you're buying a vehicle with no down payment. With a five-year $30,000 mortgage at a 4.5% interest rate, the monthly payment would be $559 (or a little more if you include sales tax in the loan).
But if you made a down payment of $6,000 and borrowed just $24,000 for the same vehicle at the same interest rate for five years, the monthly payment will fall to $447. Having the down payment would save you $112 a month.
Qualify For Special Programs
Dealers may offer special low-rate financing programs or other incentives. In some cases, these plans require you to make a higher down payment.
If dealers advertise special incentives they are required to disclose the terms, so read the fine print carefully and ask questions to make sure you understand the down payment criteria.
Offset Depreciation
Vehicles generally lose around 15% of their value each year, but newer cars have a faster rate of depreciation. They will lose 25% or more of their value in their first year.
If you don't make a substantial down payment, you could end up on your loan upside down (because you're worth more than your vehicle) as soon as you get your car off the lot.
Being upside down might make it difficult to sell or trade your car down the road, because you might not be able to get enough money to pay for what you owe on your car loan.
In Conclusion…
Making a car down payment can save you money and increase your chances of getting a mortgage — and better loan terms— especially if you have less than perfect credit.
If you do not need to buy a car right away, think about saving for a down payment before you start shopping for a car loan. Creating a budget could help you set aside money and figure out how much you can save to put on a car. And then, once you're ready, you should go out and look for a perfect ride.