A car loan rarely covers the down payment on a car. If it did, you would effectively have a loan balance that would be more than the value of the vehicle financed.
Why a Down Payment is a Good Idea
- Approval: It is not wise to purchase a vehicle without a down payment for several reasons. Number one is the higher risk of your loan being denied. A loan balance that is in excess of 100 percent of the value of a vehicle is very risky for a lender. All lenders are risk adverse, so will most likely deny nearly any loan applications under those circumstances unless you have a perfect credit score.
- Monthly Payments: Second, if you did finance 100 percent of the purchase price of a vehicle, your monthly payments would be higher. Consider the payments for a $10,000 vehicle financed at 8 percent for 48 months. When financed at 100 percent, the monthly payment would be $268.54. With just ten percent down, the payment drops to $241.69, and with twenty percent down the payment drops to $214.83.
- Negative Equity: Third, 100 percent financing leads to negative equity. Say you get a $10,000 loan for a $10,000 vehicle. A new car loses 20 percent of its value straight away. That means the second you leave the lot, you will owe $10,000 on a car worth $8000. If you want to trade it in, you will be on the hook for the difference, known as a “deficiency balance.”
- Total Interest: Lastly, the total amount of interest that you pay will be quite a bit more. Consider the loan mentioned above. Financing the total purchase price forces you to pay $1,890.02 in interest. Ten percent down drops that to $1,701.02 and twenty percent takes it to $1,512.02.
Although a car loan can techically cover your down payment, it does not make very good financial sense unless you have stellar credit, a high tolerance for negative equity, and plan to drive the vehicle until it’s fully paid off.