5 reasons to make a car down payment

Smiling man looking at new car at car dealershipImage: Smiling man looking at new car at car dealership

In a Nutshell

A car down payment is money paid upfront for a vehicle you buy. Lenders often require down payments, but even when they don’t it’s a good idea to put money down anyway. That’s because a down payment can mean paying less interest, having lower monthly payments and protecting yourself from owing more than your car is worth.
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You can think of a car down payment as the first payment you make when you finance a vehicle.

A down payment is seen as a percentage of the car’s purchase price. If you’re buying 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 paid with cash, by trading in your old vehicle or a combination of both.

Lenders often want you to make a down payment to show your commitment to paying back the loan and to get some compensation for the car upfront. As a general rule, aim for no less than 20% down, particularly for new cars — and no less than 10% down for used cars — so that you don’t end up paying too much in interest and financing costs.

Benefits of making a down payment can 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 making a down payment isn’t possible.

  1. You’ll pay less interest
  2. You may get approved for a loan more easily
  3. Your monthly payments could be lower
  4. You might qualify for special programs
  5. You can offset depreciation

1. You’ll pay less interest

The more money you put down for a car, the less money you need to borrow for the car. With a smaller loan, you’ll pay interest on a lower balance, which means your total interest cost will be less, too.

If you took out a five-year $30,000 car loan with a 4.5% interest rate, you’d pay a total of $3,557.43 in interest. But with a 20% down payment ($6,000) on the same car, you’d pay only $2,845.95 in interest on that five-year loan — a savings of more than $711.

With a down payment, you may also get a lower interest rate. That’s because your loan-to-value ratio — the amount you borrow versus the value of the car — is one factor that affects your interest rate.

2. You may get approved for a loan more easily

A down payment may help you to more easily qualify for an auto loan, especially if you have lower credit scores. Without a down payment, the lender has more to lose if you don’t repay the loan and they need to repossess and sell the car. Cars can begin losing value as soon as you drive off the lot.

3. Your monthly payments could be lower

Making a down payment and reducing the amount you need to borrow can also decrease your monthly loan payment amount. Let’s say you buy a vehicle with no down payment. With a five-year $30,000 loan at a 4.5% interest rate, your 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 car at the same interest rate over five years, your monthly payment would drop to $447. Making that down payment would save you $112 each month.

4. You might qualify for special programs

Dealers may offer special financing programs with low rates or other incentives. In some cases, these programs require you to make a larger down payment.

When dealers advertise special incentives, they’re required to disclose the terms, so read the fine print carefully and ask questions to make sure you understand the down payment requirements.

5. You can offset depreciation

Vehicles typically lose around 15% of their value each year, but new cars have a faster rate of depreciation. They can lose 25% or more of their value in their first year.

If you don’t make a substantial down payment, you could end up upside down on your loan (owing more than your vehicle is worth) as soon as you drive your car off the lot.

Being upside down could make it difficult to sell or trade in your car down the road, because you may not be able to get enough money to pay what you owe on your car loan.

What if you can’t make a down payment?

While making a down payment is ideal, not everyone can afford it. If you can’t come up with the cash, you have a few options to try to protect your finances.

  • Purchase gap insurance. This insurance helps you fill the gap between what your insurer would pay for your vehicle if it’s totaled and what you owe on the car.
  • Get new-car-replacement coverage. This type of insurance allows you to replace a new car that’s totaled with a new one of the same make, model and equipment. If you decide against this coverage and only purchase collision or comprehensive insurance, your insurance company would likely only pay you the actual cash value of the car — what the car is worth at the time it was totaled.
  • Buy a less expensive vehicle. Getting a cheaper car means borrowing less, which could result in a lower monthly payment.
  • Get a co-signer to help you qualify for a loan. When a co-signer with good credit agrees to share responsibility for loan repayment, this reduces the risk to the lender — and puts you in a better position to qualify for a loan (and a lower interest rate).

Next steps

Making a down payment on a car can save you money and increase your chances of getting a loan — and better loan terms — especially if you have less-than-perfect credit.

If you don’t need to buy a car right away, consider saving for a down payment before you start shopping around for a car loan. Creating a budget could help you set money aside and figure out how much you can save to put down on a car. And then once you’re ready, you can go out and look for your perfect ride.

About the author: Christy Rakoczy Bieber is a full-time personal finance and legal writer. She is a graduate of UCLA School of Law and the University of Rochester. Christy was previously a college teacher with experience writing textbo… Read more.