It’s not always easy to make a substantial down payment on a car, but there can be good reasons to do it even if you don’t have to. New cars depreciate fast and a substantial down payment can protect you from owing more than your car is worth. It can also help you get approved for a loan or help you get better terms on a loan, and your monthly payments may be lower.
Many experts advise making a down payment of 20% on a new car and 10% on a used car. If you are not able to make a down payment of this size, there are steps you can take to protect yourself from some of the potential adverse consequences.
The Advantages of a Down Payment
Many people see a down payment as an obstacle to buying a car. If your credit is good or a dealer is eager to close a deal you may have a chance to get a car loan with no down payment or a small down payment. Some buyers will see that as a great opportunity and grab it. That’s not always a wise decision.
Consider the advantages of making a down payment:
- A down payment can help you get approved for a loan even if your credit isn’t great.
- A down payment may persuade lenders to offer better terms.
- A down payment may lower your monthly payments.
- A down payment may qualify you for special incentives. Read the agreement carefully to be sure of what you’re getting!
New cars depreciate rapidly, losing over 20% of their value in the first year of ownership. A down payment can prevent you from going “underwater” – owing more than your car is worth – on your car loan.
Going underwater on your car loan can have several undesirable consequences:
- If you want to sell your car you may have to add money to pay off the loan.
- You may not be able to refinance your car loan.
- If your car is stolen or totaled in an accident, insurance will pay only the value of the vehicle. You’ll still be liable for the balance of the loan.
Depreciation is the primary reason why experts recommend a 20% down payment on a new car. Since the expected depreciation in the first year of ownership is 20%, a down payment of that size will protect you from being underwater on your loan.
The recommended down payment on a used car is 10%. That’s because depreciation is greatest in the first year of a car’s life and slows down as the car ages.
If you are looking for a car loan with fair or poor credit, you will want to save as much as possible for a down payment. A larger down payment will lower your monthly payment, may get you a better interest rate, and may make the difference between approval or disapproval.
What if I Can’t Make a 20% Down Payment?
There are strong reasons for making a 20% down payment on a new car or a 10% down payment on a used car. If you can’t make a down payment that large there are things you can do to protect yourself and gain some of the advantages of making a down payment:
- Make as large a down payment as you can. 20% may be the ideal down payment on a new car, but if you can’t make that, making as large a down payment as you can manage may gain some of the advantages.
- Wait to buy a car. If you have a vehicle and are looking to replace it, holding on to it a little longer could give you a chance to save for a larger down payment.
- Buy a cheaper car. Whatever amount you have saved for a down payment will be a larger percentage of the value of a cheaper car.
- Purchase gap insurance. If your car is stolen or destroyed, gap insurance will cover the difference between its value and your loan balance.
- Get new-car-replacement coverage. This insurance will replace your car with a new car just like your old one. You can expect a higher insurance bill, but in a worst-case scenario, you’d be protected against losses.
Remember that if you have a vehicle already, selling it or trading it in may cover most or all of an ideal down payment.
The Bottom Line
Making a large down payment on your car loan may not be convenient, but it’s often a smart thing to do, even if you qualify for a low-down payment or zero down payment loan.
Making a large down payment can get you better loan terms, lower your monthly payment, and protect you from the adverse consequences of going underwater on your loan.
Even if it’s not possible to make the recommended down payment on a car loan, understanding the advantages of a down payment can help you to plan a strategy to make the largest possible down payment and minimize the potential impact of not having a large enough down payment.