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Your down payment does three main things when you are buying a car. The first is lowering your monthly payments. The second is helping you secure any loan that you may need. The third is compensate for depreciation.

Advantage 1: Reduced Monthly Payment and Interest

Looking at the monthly payments. Let’s suppose that you want to buy a vehicle that costs $17,500, your interest rate is 6.75%, and that you need a loan term of 60 months. Have a look at how the much the payment drops when you put different amounts down.

  • Zero down…$344.46
  • 5 percent down…$327.24
  • 10 percent down…$310.01
  • 15 percent down…$292.79
  • 20 percent down…$275.57

In addition to the monthly savings, the amount of interest you pay over the life of the loan drops. There is a difference in total interest paid of over $630 between zero down and a twenty percent down payment.

Advantage 2: Credit Acceptance

When you apply for any loan, a lender is going to want to see that you are somewhat vested in repaying the loan. In the eyes of the lender, you show your vested interest by making a down payment. If you have excellent credit, a lender may only need to see that you are committing five percent of the total purchase price. On the other hand, if your credit is less than stellar, a lender may demand twenty percent down. Typically, you can get away with a smaller down payment on a used vehicle, simply because used vehicles don’t suffer from the big initial drop in value typical of new car purchases.

Advantage 3: Reduced Negative Equity

As you probably know, a car is a (steeply) depreciating asset. It loses value pretty much every day, and a new car loses a fifth of its value the very moment you buy it and it becomes “pre-owned” instead of “new.” This often results in negative equity, a scenario in which your remaining loan balance is greater than the value of your vehicle. This may not seem like a big deal, but what if you want to trade in your car or it gets totaled in an accident? You will be held liable for the difference between what you owe and what you get for the vehicle, known as a “deficiency balance.” A down payment keeps your loan amount more in line with the value of your vehicle. Without one, your lender may require you to carry “gap insurance,” in order to cover the deficiency balance in the event of an accident in which the vehicle is totaled.

 

About the author: Jerry Coffey

 

Jerry Coffey is the financial expert here at AutoFoundry.com. A recovered "debtaholic," he now preaches frugal-living and sound money management here and at Repaid.org, where he is the chief contributor. He works for a major automaker.

 

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