June 29, 2022
Buying a car is one of the biggest and most important purchases of your life. Therefore, it’s important to carefully weigh the various aspects of the purchase, including how much of a down payment you should make if you’re taking out an auto loan. In general, you should strive to make a down payment of at least 20% of a new car’s purchase price. For used cars, try for at least 10% down. If you can’t afford the recommended amount, put down as much as you can without draining your savings or emergency funds.
The more you can put down when buying a car, the better your financial position will be. Many people do buy cars with lower down payments. Some simply don’t have enough money saved to put down the recommended amount. These down payment amounts can include cash, the value of a trade-in, or both.
Why should I make a larger down payment?
There are several great reasons to make a larger down payment on a car. They include:
- Lower your interest rate – Typically, the more you put down, the lower your interest rate will be. Making a substantial down payment and financing less of the purchase price signals to lenders you are a lower-risk borrower. Also, with a lower loan amount, you can most likely go with a shorter-term and pay less in interest over the life of the loan.
- Lower your monthly payments – Putting more down reduces the amount you’ll need to finance and helps you to pay the loan off sooner. As a general rule, every $1,000 in the down payment reduces your monthly payment by $15 to $18.
- Lower your loan-to-value ratio – Auto loans are secured by the value of the car, and lenders have limits on how much a person can borrow compared with the value of the vehicle — called loan-to-value ratio, or LTV. Every lender has its own LTV rules for loan approval, and in some cases, a larger down payment can help you fall within a lender’s LTV ratio requirement. Also, lenders use the LTV ratio as a measure of a loan’s risk. When you borrow less than the car’s value, it reduces the risk of the lender losing money if you default on the loan. Loans considered to be lower risk tend to come with lower interest rates.
- Avoid being upside down on your loan – When you buy a new car, it loses about 20% of its value through depreciation in the first year. That’s why experts suggest making a bigger down payment on a new car than on a used one. If you make a down payment of less than 20%, you could end up owing more than the car is worth. This is called being “upside-down” or “underwater,” and it can put you in a precarious financial situation. If you decide to sell or trade the car, you will owe the difference. If you’re in an accident and your car is totaled, the insurance company’s payment — which is based on the cash value of the car — may not cover the full amount you still owe.
- Improve your chance of loan approval – If you have no credit or a lower FICO score (about 620 or below), a larger down payment can improve your chances of being approved for an auto loan. And if you are approved, you may qualify for financing with better terms and a lower interest rate. Some lenders require a down payment of 10% or $1,000, whichever is the lower amount, for car buyers with no credit or a low credit score.
Determine what makes sense for a car down payment. Because of the financial advantages, the more you can put down on a car the better. The best approach is to put 20% or more down on a new car and at least 10% on a used car if you can afford it. If these recommended percentages are out of reach, ask yourself if you can delay purchasing a vehicle. Waiting can give you time to save more toward a down payment. If you don’t have a monthly budget, create one. Determine if there are expenses you can cut and how much. Then, set up an automated transfer to a savings account to begin building a larger down payment.
How can I save for a down payment?
You can take many approaches to save up for a down payment. Here are four of them:
- Create a budget – Establishing a spending plan gives you a better handle on your income and spending and gives you a better idea of where you can carve out money for a down payment.
- Set a goal – Let’s say you want to make a down payment of $2,500. If you map out a strategy for what you’ll need to do and how long it’ll take to get there, it’ll be easier to reach the $2,500 goal line. If you can set aside $200 a month, it’ll take a little more than a year to save up enough for your down payment, so either plan your vehicle purchase around that or try to accelerate your saving if you can’t wait that long.
- Cut spending – Dialing back on big purchases, dropping unused memberships, and trimming your clothing budget are among the ways you can decrease spending and increase the amount of money to set aside for a down payment.
- Reduce the use of credit cards – Putting away your credit cards, at least temporarily, can lower your debt load. This can leave more money to put away for a down payment.
If you can’t put off buying a car, know that many people do put less down and pay off their car with no financial issues. If your financial situation improves, you can still pay extra on your car payment to keep from being upside down and pay off your loan sooner. You might also consider refinancing your car loan, which could give you a new opportunity to lower the interest rate and monthly payment.
Scraping together money for a down payment might feel like a roadblock to buying a new or used car. But whether you decide on a down payment of 10%, 20%, or another amount, you can make sure the road toward that new or used car is smooth. How? By shifting into high gear when it comes to setting aside money for the down payment, by monitoring your spending and keeping on top of your credit.