According to a 2017 analysis by Edmunds.com, the average down payment on a car (both used and new) was 12 percent. OK, that’s good to know, but should that figure be used as your baseline when determining what your car down payment should be? Probably not.
For decades, there have been two widely accepted rules of thumb for car down payments: if you’re buying new put at least 20 percent down, and if you’re buying used put 10 percent. Why those particular numbers? For new cars, it’s because that 20 percent down payment is believed to offset the car’s depreciation in its first year. You see, new cars generally depreciate by 20 percent in the first year, then 10 percent in both the second and third year (which is why buying used has its advantages). For used cars, 10 percent is typically the minimum amount required by the lender for a car down payment.
Still, with those two rules of thumb in mind, the more you can put down upfront, the better off you’ll be in the end. Here’s why …
You’ll get a lower interest rate
Just like when getting a mortgage, the higher your down payment, the better interest rate you’ll likely get. The reason for this is you’ll signal to the lender that you have the capital and thus can be counted on to pay off your debt as promised. By positioning yourself as a responsible borrower, lenders will be more inclined to offer you a lower interest rate on your car loan. This is good for you because it means you’ll be spending less money overall on your car purchase.
You have a better chance of being approved
Let’s not forget, your application for a car loan can be rejected. No one is automatically approved. That being said, if you have a healthy down payment, lenders will be more apt to approve you for a loan (even if your credit score is less than perfect).
You’ll lower your monthly payments
Car payments can be a burden if they’re eating up a big chunk of your income every month. To make sure your car payments are manageable, a sizeable car down payment could be the answer.
Let’s say you bought a new car for $16,000, with an annual interest rate of 5 percent for a 36-month term.
- If your down payment was 10 percent ($1,600), your monthly payments would be: $431.58
- If your down payment was 20 percent ($3,200), your monthly payments would be: $383.63
- If your down payment was 30 percent ($4,800), your monthly payments would be: $335.67
- If your down payment was 40 percent ($6,400), your monthly payments would be: $287.72
That’s a big difference in monthly payments from 10 percent to 40 percent. So much so that it may be worth your while to save up a bit longer to have a bigger down payment to play with. Lastly, APR and monthly payments doesn’t have to be a mystery until you go to the dealer, with the power of the internet you can see your APR and calculate monthly payments all with a few clicks online.
You’ll pay less interest in the end
When you get a car loan, even if you get a great interest rate, you’re still paying interest. Wouldn’t you want to do everything in your power to pay as little interest as possible? A simple way to do that is to lower the amount you need financed on the car by providing a bigger down payment.
I know lots of people make the argument that debt is cheap, and you won’t be earning that much interest when your money is just sitting in a savings account, but those people are probably sales people with a not-so-hidden agenda. I understand that when you make the decision to buy a car, you want it yesterday, but you’ll be doing yourself a huge favor by being patient, saving up, and not taking on more debt than you need.
So, how much should you put down?
I know this may not be the answer you want to hear, but the answer is as much as you can afford without liquidating your emergency fund or making you feel strapped for cash. If that amount is 20 percent, good on you. If it’s only 15 percent, then after reading this article, at least you now know what putting less down could mean for you.
And if you’re worried you don’t have enough money saved up to put 20 percent or more down on a new car, then buy used! Even if it’s a car that’s only one or two years old, remember that you’ll still be driving away with an almost new car for 20 – 30 percent less than the previous owner paid for it.