The general rule of thumb for a down payment on a car is 20%. Learn the benefits and how it can save you money in the long run.
Estimated reading time: 7 minutes
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How much to put down
If you’re thinking about getting a car, a down payment is a great idea. While the amount is up to you, there are several ideal guidelines.
Related: The complete guide to car loans
For new cars, try to put down 20%. For a used car, put down 10% or more. The reason it’s less for used cars is that the car has already depreciated.
Learn the benefits of putting a down payment on a car, how you can save up for one, and what you can do to lower your monthly car payment.
Benefits of a down payment
Cars are big purchases, and if you’re getting a loan, it can be a lot of money to have outstanding. That’s where the down payment comes in. It can reduce your loan amount, which can give you a little more peace of mind.
Besides lowering the loan amount, there are other benefits. It can lower your monthly payment, reduce the interest rate, and you may be able to afford shorter repayment terms.
Related: What does APR stand for?
Another major benefit is that you’ll be paying less interest over the life of the loan. While a lower interest rate makes a difference, the reduced loan amount has a bigger impact.
For example, say you got a $25,000 car with an interest rate of 4% and a 48-month term. If you followed the payment plan, you would’ve paid $2,095 of interest by the end of the loan.
Now, say you made a $5,000 down payment to lower the loan amount to $20,000 and kept everything else the same. At the end of the loan, you would’ve paid $1,676 of interest.
Placing a down payment on a car will save you money in the long run. Do your best to save up some cash to put down on your next car.
Another factor to consider is depreciation. According to CARFAX, you can expect a new car to depreciate about 20% in the first year of ownership and 15% per year up to four years after.
At that rate, a new car that’s worth $40,000 will be worth $32,000 after the first year of ownership.
Understanding depreciation is important because you don’t want to be upside down on a loan. That means you owe more than the car is worth.
A down payment is an excellent way to ensure that your loan amount isn’t more than the value of the car while you have a loan.
Lastly, it can also help your odds of getting approved for the auto loan. One of the main things that lenders look at is your debt-to-income ratio.
With a lower loan amount comes lower potential debt. This can increase your chances of loan approval.
Putting zero down
Advertisements from car dealerships boast their zero down offers. While it sounds amazing, it may not be the best idea in most situations.
There are few scenarios where it’d make sense. For example, if you have the entire amount to pay off the car in cash and are offered 0% APR without any fees, it’d be worth taking a look.
Especially if you can place the funds in a savings account, certificate of deposit, or invest it to get a return.
If you do that, consider the liquidity of the funds and make sure you aren’t spending it on other things.
Putting nothing down can do more harm than good because you may find yourself owing more on the car than it’s worth. It’s not a good feeling to be upside down on a loan.
Sometimes, you’re just not able to put anything down. If that’s the case, consider gap insurance. It covers the difference between what your insurance company would pay if your car is totaled compared to what you owe.
The bottom line is that it depends on your financial situation. Does putting zero down make sense for you? Only you can decide that.
Saving for a down payment
Most people don’t put in a down payment or put in very little. It happens because it’s all they can afford, or they don’t know what the impacts are.
Now that you know the importance of down payments, if you can’t afford to put down 10% for a used car or 20% for a new car, save for it.
Unless it’s an emergency and you urgently need a new car, the following are different ways that you can save to make a down payment on your next car:
- Create a budget.
- Set up automatic transfers to a savings account.
- Pretend like it’s a loan and transfer funds to another account every month.
- Find ways to reduce your spending.
- Eliminate debt.
If you urgently need a new car, put down as much as you can afford.
Finding affordable cars
Whether you’re buying a new or used car, you want to get the best deal possible. Edmunds is a great place to start because it gives you a good breakdown of the vehicle, tells you how much you should pay, and shows great listings.
Also, check CarGurus, Carvana, CarMax, Vroom, and TRED. When you’re buying a car, compare it to the Kelley Blue Book value to ensure that you’re not overpaying.
Looking at the Carfax report is essential because it tells you the vehicle’s history. Make sure there aren’t any red flags.
Doing your research can also help you negotiate a lower price. When you’re negotiating, be polite and firm.
Ways to lower your car payment
When you get a car loan, your monthly payment is a big commitment. While it should be something you can afford, learn ways that you can lower it.
The first way to lower your monthly payment is to make a down payment. A smaller loan amount leads to a lower payment.
It’ll also help to lower your interest rate. You can do this by improving your credit score because lenders have tiers, which is an interest rate assigned to a range of credit scores.
You can also reduce the interest rate by shortening the term. However, a shorter term means a higher monthly payment because you’ll pay off the car in less time.
It’s also important to apply with different lenders to see who can offer the best rate. When you’re applying, check with the lender to see if they offer any rate discounts.
For example, many lenders have an automatic payment discount. Typically, it’s less than 1%.
If you currently have an auto loan, think about refinancing the car. Since you’ll have a lower balance, you might be able to find a lower rate and monthly payment by refinancing.
When you’re looking for a new car and getting an auto loan, aim to put 20% of the vehicle price as your down payment. For a used car, aim for at least 10%. By doing so, you’ll offset depreciation, lower your monthly payment, and reduce the total amount of debt you have outstanding.
Featured image courtesy of Canva.
About David Em
David Em is the founder of More Money More Choices, which he launched to help you take control of your finances and build your dream life. Before More Money More Choices, David worked in leadership positions in the finance industry.