How much down payment do I need for a car loan?

Posted 06.07.2023

How much down payment do I need for a car loan?

When you finally find your dream car and the perfect lender, one big question remains: “How much down payment do I need for a car?” The money you pay upfront impacts your interest, monthly payments, and loan approval. So, it’s important to gain insight into how down payments work.

To make things easier, we settle what’s a good down payment and why you should put down money for your car.

How much of a down payment should you put on a car?

In reality, there’s no hard rule on how much down payment you should put on a car loan. However, many financial experts recommend that you put down at least 20% of the vehicle’s price. So, for instance, for a car worth $30,000, it would be ideal to have at least $6,000 as a down payment.

Reaching the suggested 20% down payment can be quite easy if you have enough savings. But it’s important to not drain your savings for the down payment alone. Remember, you need to meet your loan payments, too.

If you have a current vehicle, you may also trade it off to cover a portion of your down payment. Though if it’s not yet paid off, be wary if you owe more than the current’s vehicle’s value. You still need to pay the loan balance that the trade-in amount can’t cover.

Why your car down payment matters

While 20% can be a hefty sum, there are undeniable advantages to putting down a larger amount. The bigger your down payment, the lower your loan amount is. That said, your monthly payments become more manageable, and you pay less in interest over the life of the loan.

Other than lower loan costs, having a high down payment also increases your chances of approval. Your lender takes less risk when you have a lower loan amount, so they may favor your application. Plus, they may offer you more favorable rates and terms.

How to calculate a down payment

When calculating your down payment for an auto loan, it’s typically a percentage of the final purchase price. Here are a few scenarios to give you a clear picture of what your down payment may cost you:

Down payment on a 20k car

5% down payment would be $1,000
10% down payment would be $2,000
20% down payment would be $4,000

Down payment on a 25k car

5% down payment would be $1,250
10% down payment would be $2,500
20% down payment would be $5,000

Down payment on a 30k car

5% down payment would be $1,500
10% down payment would be $3,000
20% down payment would be $6,000

Say you trade in your current vehicle as part of your down payment, and the dealer values it at $3,000. You only need to pay $3,000 upfront if you want to put down 20% for a $30k car.

Consider talking to multiple lenders to assess how varying down payment options affect your interest and monthly payments. This way, you can settle for an amount that won’t throw off your budget.

Why should you put a down payment on a car?

When you buy a new or used car, putting a substantial down payment provides several benefits that are worth considering. This can help you save more money, reduce financial risks, and improve your overall car-buying experience.

Pay less interest

One advantage of a down payment is it decreases the amount you have to borrow. Say you put down $1,500 for a car worth $20,000; you only need to borrow $18,500. This, in turn, lowers the overall interest you incur over the life of the loan.

Other than that, a down payment lowers the risk for lenders. With that, they may offer you lower interest rates, saving you a significant amount in the long run.

Reduce your monthly payments

Since an upfront payment allows you to borrow less, you reduce your monthly balance, too. Let’s take a $25,000 car with a 4.99% interest rate and a 48-month loan term as an example. If you put down $1,000, your estimated monthly payment is $552.59. But if you increase your down payment to $5,000, your monthly dues may go down to $460.50 – saving you around $92.09.

This then makes your loan payments more affordable and easier to manage within your budget. In turn, you have greater flexibility with your expenses and prevent financial strain.

Lower your loan-to-value ratio

Your loan-to-value ratio (LTV) is expressed in percentages. Lenders calculate this by dividing your loan amount by the car’s value. So, if you borrow $23,000 for a $31,000 car, your LTV ratio is 74%. That said, when you put in a bigger down payment, your LTV ratio also decreases.

Though banks, credit unions, and dealerships differ in LTV limits for auto loans, the lower your ratio, the less risky it is for lenders. Meaning you become an appealing borrower if you have a low LTV ratio. So, lenders may favor your application and offer you better rates.

Improve your chances of getting approved for an auto loan

A sizable down payment increases your chances of loan approval especially if you have a low credit score or limited credit history. Since lenders consider your down payment a positive indicator of your financial capacity, they may view you as a low-risk borrower. In effect, this gives your application a leg up and helps you qualify for more favorable loan terms and rates.

Avoid being upside down on your loan

Car values drop quickly, so the moment it hits the road, your car loses some of its value. So, with a low or no down payment, you’re at risk of being upside down or underwater on your loan. Simply put, you owe more than the car’s current value – having negative equity.

Say your car’s value dips to $13,000, and you have $16,000 left on your balance. Your loan is upside down. When this happens, it becomes harder to trade in the car, refinance the loan, or sell the vehicle altogether.

Can you buy a car without a down payment?

If you’re in a tight spot but in need of a car, you may think about no-money-down loans. These car loans don’t need any down payment. But even if this helps you buy a car instantly, ensure you weigh the potential downsides first.

Without a down payment, you have to take out a larger loan. This leads to higher monthly payments and total interest charges. And since your loan amount is high, your loan term may also be longer, which makes your loan more expensive. A longer loan term puts you at risk of being in an upside-down situation.

If you risk not making any down payment, it’s wise to consider gap insurance until you build enough equity. Gap insurance covers the difference between your remaining balance and the car’s value if it gets stolen or totaled.

The disadvantages usually outweigh the benefits of no-money-down loans. So, if you can wait it out, it may be more worth it to save for a down payment. This way, you avoid the potential risks, like having negative equity or lenders repossessing your car.

Summary

With a large down payment, you can have lower monthly payments and better interest rates. Nonetheless, make sure you balance the benefits and stakes you take with your car loan. So, understanding how much down payment you can make helps you explore your options, plan your finances, negotiate ideal terms, and save more.

Carla Soto

Carla is a skilled copywriter at BestFind with a background in marketing and communications. She specializes in reviewing personal loan and finance products to help readers navigate the complex world of personal finance.