Automotive Loans: Determining a Down Payment

by Amy Lillard

(2/5/2013)When buying a car, the goal is deceptively simple — get the right car for your needs, at the right price. To do this, you can employ a variety techniques at your disposal, including online research into cars and financing, and obtaining a loan before stepping on the lot.

Another way to take control and gain a better deal is choosing the right down payment.

A down payment is the amount of money you can place towards the purchase of a car. When financing a car, the loan amount is the price of the car (and associated fees) minus the down payment. As with other major loans like mortgages, experts typically recommend a down payment of at least 20 percent. But with today's variety of financing options, and historically low interest rates, the amount of down payment you provide is entirely up to you.

So how do you decide how much to put down?

In general, the bigger the down payment, the less you need to finance. Lenders are more likely to view you as a strong candidate for financing, one that will pay back the loan without issues. That can mean you receive better loan terms, including a lower interest rate and fewer fees. If you have less than stellar credit, the bump you'll receive from a higher down payment can mean the difference between an affordable car and a burden.

With new cars, a bigger down payment can offset the effects of depreciation. The value of new cars instantly begins to plummet after purchase, with the average rate of depreciation over the first year of purchase more than 20 percent. A higher down payment accounts for this loss in value, and ensures your loan isn't more than the car is actually worth. And it will ensure a buyer actually has equity in the car earlier.

A bigger down payment is even more powerful for used cars. As car prices are lower for preowned cars, a bigger down payment can further reduce the amount of loan you need.

With these benefits in mind, it's advisable to make as large a down payment as possible. But where do you find the money for a down payment?

A down payment can come from money set aside, including savings or other means. But don't forget about the money that can come from trading in an existing car. Trading in existing cars can be a bit tricky, and the amount of money you'll receive will vary by car, market area, and dealership. But there are ways to maximize the amount you receive, including diligently researching the car's value in the Kelly Blue Book. Armed with this information, you can negotiate a better deal that counts towards your down payment.

What's the moral of the story? Pay as much in a down payment as you can. The more you put down, the better position you'll be in at purchase, and over the life of the loan.

A frequent contributor to ERATE® since 2006, Amy Lillard is a freelance writer specializing in turning complex information into useful tips and tricks for readers. For questions or topic suggestions, contact Amy at [email protected].

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