One of the most common questions about buying a car is, “Do I need to make a down payment?” For those who have decided that making a down payment is a good idea, they often wonder how much money they should put down. The truth is, you should only make a down payment if your credit score is less than optimal. If you have a good credit score, a down payment is not necessary. Here are a few reasons that banks ask for a down payment:
1. The bank wants to know that you are serious. Paying money up-front on a loan shows the bank that you are committed to repaying the loan. Banks often require a down payment if you have had past credit problems or if you do not have an established credit history.
2. A down payments makes the loan safer for the bank. If your credit is poor, it indicates that you might default on the loan and the bank will require a down payment. However, if you have good credit, the bank does not need a down payment to prove that you will not default.
How Much is Sufficient?
If you do need to make a down payment, it is important to consider how much you should pay. The truth is, it depends on the vehicle. Down payments are much more important if you’re financing a new car. You’ve probably heard the old adage that a car loses 20% of its value the moment it leaves the dealer lot. Well, what happens if you lose your job the next month? You will only be able to sell the vehicle for 80% of what you paid for it. If you financed 100% of the purchase price, you’ll still owe 20% of the loan. That’s called negative equity, and according to this Benchmark International report, 25% of new car loans are underwater at an average amount of -$4250. For these reasons, the rule-of-thumb for many years was 20% for new cars and 10% for used cars.
Down Payment vs Emergency Fund
Of course, in the above scenario, if you tucked away the 20% in an emergency fund, you might be okay. If you have plenty of income and good credit, you should probably put as little down as the bank or lender will allow. Because cars lose value quickly, it is often more beneficial financially to use this money to pay other bills. For instance, you can use this money to pay off credit card debt. Remember it is also a good idea to have an emergency fund so that you can pay your bills even if you go through a period of unemployment.
In this way, down payments can be a bit of a personal preference:
- Big Down Payment: Less risk of negative equity, smaller monthly payments, less money in savings account for emergencies.
- Small Down Payment: More risk of negative equity, bigger monthly payments, more money in savings account for emergencies.
Of course, if you have credit problems, you may not have the luxury of making such a choice.
Down Payments for First-Time and Credit-Challenged Buyers
If your credit is poor or you are a first time buyer, the bank will expect you to put at least 10 percent down. In some cases, the bank may want 20 or 30 percent down. However, it is important to be aware that if you are buying a car for the first time, there are some programs that allow you to buy a car with no money down. Ford and Toyota occasionally offer these types of programs.
There is an instance when a down payment can be very beneficial for you as a customer. If you can get a lower interest rate on your loan with a down payment, then it is important to take this opportunity. Sometimes a bank can give you a lower interest rate if you put down just $500 to $1000 extra. This will save you a substantial amount of money over the life of your car loan.
Remember that you should only make a down payment if your credit requires it, or if it will give you a better interest rate or less risk of negative equity. If you follow these tips, you will be more likely to get a loan that works for you