What is a Down Payment?
In case you are new to the concept of using a loan to purchase large ticket items, a down payment is an amount of cash you would give to a lender up front.
In the case of borrowing to purchase a car, there are a couple of reasons why a lender might require a down payment.
First, it shows the lender that you are capable of earning a wage and have displayed self-discipline in saving some of your earnings instead of spending everything you earn.
Secondly, the down payment will insure the lender against taking a loss should you default on the auto loan. This is especially true when buying a new car.
When you purchase a "new" car it instantaneously becomes a "used" car -- in which case the perceived value of the car to others drops significantly (as much as 20%).
This means that if you were to purchase a new car with zero down payment, and then default on the loan after only making a handful of monthly payments, the lender would not be able to sell the repossessed car for as much as you owed them for it.
By requiring a 20% cash down payment on new cars, lenders lower their risk of losing money on car loans that go into default.
How Much Should You Put Down on a Car?
The size of the down payment you should make depends on whether or not you have a choice in the matter.
If your credit score is below 700, the lender may require a down payment percentage of 20% or more.
On the other hand, if your credit score is above 700 you may not need a down payment at all (zero down), though this is typically not recommend. Why not? Because the larger the down payment you make ...
- The lower your monthly car payment will be.
- The less interest you will pay on the auto loan.
- The less likely you will end up in an "upside down" loan (loan balance is greater than the car's resale value).
To illustrate the benefits of making a larger down payment, consider that for every thousand dollars you put down on a car, your payment will be reduced by $15 to $20 per month, and you will save $50 to $200 on interest (depending on loan's amount, rate, and term).
How to Calculate Down Payment for a Car
To find the down payment needed for certain car, follow these steps:
- Convert the required down payment percentage to a decimal number (divide percentage by 100).
- Multiply the price of the car by the decimal number from step #1 to get the required down payment amount.
- Subtract result of step #2 from the purchase price to get the amount left to finance.
How to Calculate Down Payment Percentage
To determine what percentage your cash down payment represents, follow these steps.
- Divide the cash you have available by the vehicle's purchase price.
- Multiply the result of step #1 by 100 to get the percentage.
How Much Car Will My Down Payment Afford Me?
How Borrowing Money Undermines Good Decision Making
If every day for the past 5 years you had to cut back on spending for things, activities, and events that you would have liked to spend money on, for the purpose of saving up $25,000 to pay cash for a new car, how eager would you be to hand that $25,000 in cash over to the car dealer?
Would you be more apprehensive and cautious when spending $25,000 in cash than you would if you were signing papers for a $25,000 loan?
Well, if you're like the rest of us, you probably find it much easier to sign loan papers than to part ways with a large chunk of cash. That's because we are painfully aware of the hard work and sacrifice that went into earning and saving up cash.
When taking out a loan we can't assign any value to the money we are borrowing because we haven't yet had to do the hard work and make the sacrifices. That's what makes easy access to credit so dangerous, because it appears to be the path of least resistance. In reality, it's not -- because you have to work and sacrifice to pay back what you borrow ... plus interest!
The "Act as if ..." Principle
If you haven't been scrimping and sacrificing wants for the past 5 years in order to pay cash for a vehicle, but you are in dire need of reliable transportation, then you probably have no choice but to borrow money to purchase a car. But that still shouldn't stop you from finding the best car with the lowest price and ownership costs.
Somehow you need to approach this purchase as if you had been scrimping and sacrificing for the past 5 years. Force yourself to do the same painstaking research and deal shopping as if you're actually paying for the car out of your savings account. Otherwise you're probably going to end up spending more than you would on more car than you are willing to work and sacrifice for.
Larger Down Payment in Your Best "Interest"
I created the car down payment calculator to help you to see how much interest you could save just by putting off your car buying decision for as long as you can, if only for the purpose of being able to put more money down on the vehicle purchase. Because the larger the down payment you can make, the less you will you will have to pay out (work and sacrifice) for interest charges.
Obviously, if your present vehicle is on its death bed, then waiting may not be an option. If that's the case, I urge you to begin scrimping and sacrificing now. That way, the next time you are in dire need for a vehicle, not only will you be able to make a much larger down payment, but parting with cash won't undermine your natural problem solving abilities like simply signing your name on the loan application will.
By paying cash you will likely make a much better, more informed, more self-supporting car buying decision.