When buying a new or used car, you'll pay for the vehicle in cash, or you'll need to finance it. Financing is necessary when you cannot pay for the vehicle in full at the time of purchase or when you believe your money can earn more interest for you elsewhere as an investment. Either way, if you finance a car, the amount you borrow depends on the vehicle's cost and the amount of your down payment.
A down payment on a car is a percentage of the vehicle's total cost that you will pay at the time of purchase. For example, if the car you're buying costs $25,000, a down payment of $2,500 is a 10% down payment.
If you're buying from a dealership and have a trade-in, you can apply the trade-in value to the down payment. Using the example above, if you have a trade-in worth $5,000, you can make a 20% down payment on the new vehicle without taking any money out of your bank account.
The size of the down payment affects almost every aspect of the loan, such as the interest rate you'll pay, the amount of your monthly payment, and the length of the loan. The larger a down payment you make, the more favorable the rest of the loan terms will be. This means that you will pay less for your car during the life of the loan than someone who makes a smaller down payment.
Most financial institutions offering new car loans give the best terms to customers who can make a 20% down payment. The actual deal that you negotiate with a dealer also depends on your credit score, but the ability to put 20% down will usually result in the favorable terms the dealership or automaker is advertising.
However, most people financing new cars are unable to make that size of a down payment. According to reports, in 2019, the average down payment on a new car loan was just under 12%. Considering the average price of a new car sold in the U.S. is more than $38,000, and 69% of Americans have less than $1,000 in savings, this is not surprising.
Still, a 20% down payment is the magic number because it allows you to cover the vehicle's depreciation cost, which usually amounts to about 20-25% during the first year of ownership. If you make a 20% down payment, and you have to sell the car in its first year, you're unlikely to be upside down on the loan, wherein you owe more for the car than it's worth. Because you're paying for this depreciation upfront, your lender may offer a lower interest rate on a loan.
A loan for a used vehicle requires a smaller down payment. Usually, 10% of the car's value will suffice. That's because a used car already has lost much of its original value through depreciation.
Some automakers give highly attractive deals to those who qualify, including loans requiring no down payment or 0% interest financing.
If you can, find a 0% interest loan on a vehicle. Even if you can pay for the entire car at the time of purchase, this kind of loan costs you nothing extra, allowing you to invest your money elsewhere. Essentially, it is like getting free money. You save money in terms of the interest on the loan interest, and you can put that cash elsewhere to earn money in terms of the interest on the investment
However, even with a low- or no-interest car loan, if something happens to the vehicle and your insurance company declares the car a total loss, you could wind up owing more than it is worth. If you have the cash in liquid funds to pay for this possibility, make as small a down payment as is necessary. If you do not, you may still wish to put 20% down rather than roll the dice and gamble.
The old adage says that you've got to have money to make money. In terms of buying a car, having money saves you money. Making a sizable down payment helps you to spend less, while those making a smaller down payment could end up paying more.
This article is for informational purposes only. It should not be considered financial or legal advice. Though gathered from trusted sources, the information may not be accurate or may have changed since this article was published. Always consult a financial professional before making any significant financial decisions.
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