So, you’re ready to buy a car. You’ve done your research, sold your old car and found the perfect set of wheels. Now you’re wondering how much of a down payment to make. Most people you ask say 20%, and that’s usually right.
In general, it’s wise to make a down payment of at least 20% on that new car — if you can afford it. If you can’t hit 20%, get as close as possible. It will increase your chances of getting a loan on favorable terms, keep your monthly payments low and make it less likely that you’ll find yourself “upside down,” or owing more than the car is worth.
Twenty percent seems high, right? Many people do buy a car with less. The average new-car buyer put down just $3,502 in 2014, about 11% of the average new car price of $33,000. Used-car buyers put down even less. Six grand for a down payment may feel like a hefty chunk of change, so why shell out?
There are a lot of reasons:
- You may get better terms on your loan, including a lower interest rate.
- You’ll increase your chances of getting approved for a loan.
- The monthly payment will be lower, and you’ll pay less in total interest over the life of the loan.
- You’ll have more equity in the car, increasing your feeling of ownership.
- It helps you avoid owing your lender more than the car is worth or more than you’d get from insurance if the car is totaled.
- A higher upfront payment will help keep your overall debt level manageable — but keep market conditions in mind.
Lower interest rate
A substantial down payment signals to lenders that you’re committed to the car and therefore represent a lower-risk borrower, so some lenders will give you a better interest rate.
Better chance of loan approval
If your credit score is less than excellent, a large down payment can help you qualify for financing. “Keep in mind that buyers don’t necessarily need all the money in cash. Two common ways to bolster the down payment are with a trade-in vehicle or with a cash rebate on the vehicle’s purchase,” says Brian Moody, executive editor at Autotrader. If your FICO score is 670 or below, you’ll have a better chance of getting a loan from a bank or credit union if you can put at least 15% down, according to the auto website Edmunds.com.
Lower monthly payments
More money down means less to pay each month, and less interest paid over the life of the loan. “If you can’t secure low financing for whatever reason, making a bigger down payment — or buying the car outright — can save you significant money in financing costs,” says Jason Allan, managing editor for Kelley Blue Book’s KBB.com
More equity
The more you put down, the more equity you’ll have. One reason for the 20% benchmark: It’s about what a new car loses in value through depreciation in a year. “Depreciation is about 20.5% in the first year, so a 20% down payment essentially offsets the first year of depreciation,” says Ron Montoya, senior consumer advice editor at Edmunds.com.
Avoid being ‘upside down’ on your loan
If you make too small a down payment on a car, you could end up owing more than the car is worth. An extreme example: You’ve probably seen dealerships advertising zero-down deals. While these deals are popular, they can be risky.
With a 100%-financed deal, you’d owe more than the value of the car, because the loan would include the purchase price plus sales tax, interest and other fees. “If you put zero down, right off the bat the car is already worth less than the loan that you’ve taken out,” Montoya says.
That’s called being “upside down” or “under water,” and it’s financially dangerous. If you’re upside down, you may not be able to trade in the car if you want to buy a new one, or you may have to roll the amount you still owe into the loan for the new car. 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.
Keep debt level manageable — but consider market conditions
One final factor: Is it cheap or expensive to borrow money right now? When interest rates are high, you want to scrape up all the cash you possibly can to keep your loan (and the amount spent on interest) as small as possible.
But when interest rates are low, as they have been for several years, a smaller down payment can make sense. “When rates are low, even if you have money available to pay cash for the vehicle, the best option may still be to take out a loan. That allows you to keep the money, perhaps invested with a higher rate of return,” says Mike Buckingham, senior director of the automotive financial practice at J.D. Power.
If you can put your money to work and earn extra income from the investment, then a smaller down payment may be appropriate.
[More: Can You Save Thousands of Dollars by Buying a New Car with a Loan Instead of Cash?]
The bottom line
When it comes to car down payments, bigger is usually better. While many people put down less and do fine, the best strategy is to put down 20% or more if you can afford it. That will bring you lots of financial advantages to enjoy during your years of car ownership.
Jeanne Lee is a staff writer at NerdWallet, a personal finance website. Email: jlee@nerdwallet.com.
Image via iStock.
from NerdWallet Credit Card Blog
http://www.nerdwallet.com/blog/loans/how-much-down-payment-make-buying-car/
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