What is a down payment? And how much should I put?
This is part of our car buyer’s glossary series which details all the terms you need to know whether you’re buying a new or used car from a dealership.
A down payment is the amount you pay up front when you finance a new vehicle. To the right? What more is there?
Well, a lot. But you know the basics. The deposit is indeed the money you pay at the time of purchase. The down payment is determined when you apply for financing. There is usually a minimum down payment for a given loan, although it’s usually no problem to put down more money than that.
Generally, you want to pay a deposit equal to 20% of the value of the vehicle.
20%? It’s a lot! I don’t have that kind of money lying around.
We hear you. That’s a lot of money. But depositing 20% has a lot of advantages. Remember, the second you drive the car off the lot, it’s a used car – and its value drops instantly. And it keeps dropping the more miles you put into it. It’s just a fact of life when buying a car.
But depositing money “neutralizes” this loss of value. If something wild happens – like a meteor hits the dealership just as you sing the paperwork – you won’t have negative equity in the car. This means you won’t owe more than it’s worth.
A meteor, huh? Well, I’m not worried about that.
It was a ridiculous example, but it’s a dry subject and spicing it up a little helps. To the right?
Alright, back to the subject. Putting more in advance will save you a lot of interest down the road. Whatever is included in your loan, you pay interest. And if your credit score is good but not great, putting more money aside will help you get a better loan. Remember that the less the bank has to lend to you, the less risk there is for the lender. Lenders hate risk.
This all sounds good, but have you seen my bank account?
Well, if you need less money, you can protect yourself to some extent with gap insurance. For some buyers, this is a good decision.
You can read more about gap insurance here.
And there is also your exchange! This counts as part of your down payment. Make sure you know the fair trade-in value of your car before you go to the dealership. Trade-in values are usually much lower than what you could get selling the car yourself. The dealer must make a profit, after all. But unless your trade is a total heap, this will reduce what you need to deposit.
Do I have to remove all fries from under the seat before the dealership sees my trade-in?
Yeah. Go do that. And also you make us hungry for fries.
Sorry? (Not sorry.)
It must be lunch time. Either way, would you like to put zero money on your next car?
Hey, what’s up? You told me to do 20% all the time here!
You are right. Zero percent offers are really meant to entice people. Once there, they might discover that they are not eligible for such an agreement. You really need great credit to do that. And also, it’s not great for you from a financial standpoint for all the reasons we’ve mentioned above. It gets expensive over time, you won’t have any equity in the car, and you’re probably not even going to get it. Remember that just because you can do something doesn’t mean you should. Like getting fries instead of a salad.
OK, enough with the food analogies.
Sure thing. We’re pretty much done on the subject. While you don’t have to put down 20% on every loan under all circumstances, it’s a good rule of thumb and a good starting point for thinking about the whys and wherefores of down payments. Good luck with your purchase!