Many drivers crunch the numbers and decide it’s the right choice to buy a new or used car rather than lease one, particularly if they want to drive the vehicle for more than a couple of years and trade it in for value down the road.
However, buying a car is a major expenditure, one requiring most people to borrow the money to do so. Meanwhile, taking out a loan typically requires putting down a certain amount of money up front — for a number of reasons.
Here’s why you need to make a down payment on a car loan.
How Much Are Down Payments on Cars?
A longstanding rule of thumb for buying a car is to put about 20 percent of the vehicle’s value down as an initial payment. However, studies have shown drivers are trending toward making smaller down payments over time. Research from Edmunds on new and used car purchases found the average down payment on a vehicle loan to be 11.7 percent in 2019.
There are a few key reasons why drivers may be paying less up-front when they buy a car. First of all, the cost of getting a vehicle has increased by one-third, also according to Edmunds. So, more and more people find their savings shy of 20 percent.
The good news is it’s absolutely possible to get a car loan with a smaller down payment, or no down payment at all. Before doing so, though, it’s helpful to understand the function of down payments and the risks you’re taking by reducing or skipping them.
Why Is a Down Payment on a Car Loan Important?
As with most things in life, the price you see on the window of the car isn’t the exact amount you’ll owe if you decide to go ahead with the transaction. It’s safe to anticipate you’ll face some fees and taxes, too. The down payment helps protect you against owing more than the car is worth once depreciation and those extra expenses are factored in.
Say you pick out a $20,000 car. The transaction comes out to $22,000 without a down payment due to fees and taxes. You drive your car off the lot and — just like that — its value starts to depreciate. As Experian notes, it’s common for cars to lose one-fifth of their value in the first year off the lot. So, now you have a car worth about $4,000 less than the day you bought it — $16,000. The tricky part is that you took out a loan for $22,000 and are still working on paying it back. This is what’s known as being “upside down,” or owing more than your car is worth.
Making a down payment helps minimize the degree to which you go upside down, if at all. Another way to think of being upside-down in a loan is having negative equity, something that becomes a serious problem if your car is totaled or you fall behind on payments.
Besides counteracting depreciation, other key benefits of making a down payment on a car loan include:
– Paying less in interest
– Lowering monthly payments
– Improving your chance of getting approved
– Qualifying for special financing offers
As you can see, it’s in every driver’s best interest to come up with a down payment before purchasing a vehicle. If 20 percent is out of the question, it’s still worth trying to pay as much as you can up front.