If you’re planning to finance a car soon, you may be wondering how much to save up for a down payment. After all, some lenders give borrowers the option to seal the deal with no money down. In this way, you can keep more of your hard-earned money in your pocket for now.
However, this could be a costly move later on down the line. Here’s why.
What Is a Down Payment?
A down payment is an amount you pay out of pocket towards the vehicle’s purchase price. So, if the car costs $30,000 and you agree to put 10 percent down, you would make a down payment of $3,000.
Why Your Car Loan Down Payment Matters
There are several reasons why the down payment on your car loan is important.
Lower Interest Rate
The lower the loan amount, the less interest you’ll pay over the loan term. Plus, the lender could offer you a lower interest rate since they’ll be assuming less risk.
To illustrate, if you take out a four-year $25,000 car loan with a 3.5 percent interest rate, you’ll pay $1,827 in interest. If you make a down payment of $5,000 and get a reduced rate of 3 percent, you’ll only need to borrow $20,000, and the amount you’ll pay in interest over the loan term will drop to $1,249. That means you save almost $600 simply by paying that $5,000 now instead of later.
Lower Monthly Payments
A lower loan amount also means you’ll get more affordable monthly payments. Using the example above, the monthly payment on the $25,000 loan is $559. However, it decreases to $447 on the $20,000 loan (assuming the same interest rate), which is a little over $100 less paid per month or $1,344 per year less in monthly payments.
Lower Loan-to-Value Ratio
Each auto lender caps the loan-to-value ratio at a certain percentage. It’s the amount you’re allowed to borrow compared to the car’s value, and a down payment can help ensure you don’t encounter issues when you apply for financing.
Higher Chance of Loan Approval
A higher down payment could boost your approval odds if you have less-than-perfect credit or an excessive debt load. The lender wants reassurance that you’ll make timely monthly loan payments, and putting more money on the table means they won’t have to assume a high level of risk. Furthermore, they stand to lose less if you fall behind on the payments and the lender has to repossess the car.
Offsets Depreciation
On average, cars depreciate at a rate of 15 percent annually – some new cars lose up to 25 percent of their value in year one. So, if you’re unable to make a down payment, you could find yourself upside down on the loan (meaning you owe more than it’s worth) sooner than later. Unfortunately, it’ll be rather difficult to trade your car in for another ride or refinance to secure more competitive loan terms.
How Much Should You Save for Your Car Loan Down Payment?
Ideally, you want to make a down payment of at least 20 percent of the purchase price for a new vehicle. If you’re buying a used car, experts recommend 10 percent or more to get the best deal on financing.
In many cases, consumers looking to finance their vehicle purchases can’t afford to make such a hefty down payment without emptying their emergency fund. If you can relate, it’s more sensible to lower your budget or make a down payment that you can afford, even if it’s not the suggested 20 or 10 percent.
Other Things to Consider Aside from Down Payment
Beyond the down payment, there are other factors to be mindful of when purchasing a new ride:
Trade-In Value
Are you planning to trade in your current vehicle? If the dealer offers you $8,000 (and it’s already paid off), this amount can be added to your down payment.
Car Sales Tax
Sales tax on your vehicle purchase can catch you off guard. Many lenders let you roll this amount into the loan to avoid paying upfront. But this also means you’ll pay interest on sales tax, which could be very costly.
Car Loan Interest Rate
Your interest rate, or cost of borrowing, should also be considered. A higher down payment could qualify you for a lower interest rate and possibly save you hundreds or even thousands of dollars over the loan term.
Car Loan Term
An extended loan term means you’ll get a more affordable monthly payment, but there’s a downside. The lender will also have more time to collect interest from you, and you risk being upside down in the loan for some time.
Consider Auto Refinancing Instead to Help You Save for a Car Loan Down Payment
Are you having trouble saving up for a down payment? If you currently have an auto loan, consider refinancing to free up funds in your budget.
Several financial institutions offer auto loan refinancing. However, it can still be hard to find a new loan that suits your needs and budget. But there are lenders who let you compare options in seconds with no impact on your credit score.
