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.
The size of your down payment can affect your loan in several ways, including the monthly payment amount, interest rate and repayment term. It can include cash, the trade-in value of the vehicle you drive now or a mix of the two. When it comes to a down payment on a new car, you should try to cover at least 20% of the purchase price. For a used car, a 10% down payment might do. Part of your decision will depend on where your credit score stands.
How Big of a Down Payment Should I Make on a Car?
There’s no one-size-fits-all answer for how much of a down payment to make on a car. Key factors that drive how much you should put down include whether you’re buying a new or used car, along with what your credit situation is.
Down Payment on a New Car: 20%
Is it possible for you to make a 20% down payment? If so, it could pay off. Why? A lender might extend better terms, such as a lower interest rate, when you make a substantial down payment.
Furthermore, a 20% down payment might help shield you from depreciation. Depreciation refers to the ever-shrinking value of your car. The value of a new car declines about 20% in just the first year. Each year after that, there’s even more depreciation.
A down payment lower than 20% might put you “upside down” on your auto loan, meaning you’ll owe more on your loan than the car is worth. If you wind up selling the car while you’re upside down on the loan, you’ll need to come up with money to bridge the gap between the sale price and the loan balance.
Another thing to think about: If your car is totaled or stolen, your auto insurance policy will cover only the depreciated market value of your car when you have what’s known as “actual cash value” coverage. Optional “replacement cost” coverage typically would pay you more money for a totaled or stolen car. With actual cash value coverage, you’d be on the hook for paying off the remaining balance on the auto loan.
Down Payment on a Used Car: 10%
Now, what if you’re taking out a loan for a used car? In this case, a down payment of about 10% might be sufficient to ensure you don’t end up being upside down on the loan. That’s because the value of a used car already will have depreciated quite a bit.
How Big a Down Payment Should I Make if I Have Bad Credit?
If you’ve got a low credit score, it can be very helpful to come up with as much cash as you can for the down payment. Why? This will reduce the size of the loan you’ll need to cover the cost of the car, which brings down the lender’s risk. If a lender is more comfortable taking you on as a borrower, you may have an easier time getting approved for financing, and could be offered better terms, including a lower interest rate.
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 monthly payments: When you make a larger down payment, the size of your loan will be smaller. Compared with a loan with the same terms but a smaller down payment, your monthly payments will be lower.
- Shorter loan term: A larger down payment could remove the temptation to stretch out your loan over a longer period in an effort to reduce monthly costs. For instance, with a larger down payment, you might pick a 48-month term rather than a 60-month term. A shorter term means you won’t have the debt for as long, and a larger down payment can keep your monthly payment down.
- Less interest: With a larger down payment and shorter loan term, you’ll pay less in interest charges over the life of the loan.
Making a larger down payment can have many benefits, but when trying to figure out the right amount for you, be sure not to drain your savings accounts for the sake of the above benefits. It’s key to keep enough money in your bank account to act at least as an emergency fund. Depleting your assets can also set you back in your progress toward other financial goals, such as a down payment on a house.
How to Save for a Down Payment
You can take many approaches to saving 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.
You might even pursue all four of these strategies to save for a sizable down payment. You may also borrow money from a friend or family member, take on a second job, sell your old car or sell other belongings. If you don’t think you’re able to save enough, you might consider looking for cheaper driving options.
How to Lower Your Monthly Car Payment
If your goal in making a larger down payment is to reduce your monthly costs, making a bigger down payment isn’t your only option. Explore doing the following:
- Bump up your credit score. A higher credit score can lead to a lower interest rate and, therefore, a lower monthly car payment. If you check your credit score and don’t like what you see, you can take steps to improve it such as paying your bills on time, chipping away at your credit card balances and catching up on past-due payments.
- Shop around for auto loans. Check with various lenders, including banks and credit unions, to see who might offer the best lending terms (including an attractive interest rate). With that information in hand, ask the car dealership whether it can offer a better financing deal.
- Lower your expectations. So, you’ve got your eye on a fancy brand-new sports car. Well, getting behind the wheel of that ride might come at a steep price. Maybe you can buy that car if you settle for the base model without any of the bells and whistles. Or perhaps you can settle for a less costly but perfectly fine new model that will still get you where you need to go. Or you might even choose a top-quality yet lower-priced used car.
The Bottom Line
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, monitoring your spending and keeping on top of your credit.
The post How Much of a Down Payment Should You Make on a Car? appeared first on Experian’s Official Credit Advice Blog.
https://www.experian.com/blogs/ask-experian/how-much-of-a-down-payment-should-you-make-on-a-car/
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