Even if you plan to finance your next car, you may still need to make a down payment on that auto loan.
Let’s face it: Only a fraction of us will ever use cash to buy a car outright. In fact, according to a recent study by Experian, more than 85% of new car purchases were financed last year.
But just because you’re taking out a loan for your next car doesn’t mean that you will walk out the door without paying anything. There’s still your down payment to consider.
A down payment is a partial contribution that you, as the buyer, are expected to make when you finance a purchase. Down payments are typically required to be made in cash, and are commonly requested for auto loans as well as home mortgages.
A down payment is essentially the bank’s way of ensuring that you also have a little “skin” in the purchase, instead of your lender taking on all of the risk. Depending on how small or large of a down payment you make, though, you also have the ability to impact your auto loan terms and scheduled monthly payments.
There are a few great reasons to fork over a down payment on your new car purchase. Here’s a look at the ones we consider to be most valuable.
1. Better Approval Rate
In some cases, a down payment is unavoidable; there are some lenders who will require you to contribute a certain amount toward your vehicle purchase, even if the rest is being covered by an auto loan.
Whether your lender requires you to put up a down payment or not, doing so can boost your loan approval odds. Plus, offering to make a larger down payment can expand your auto loan offers even further, and may result in better loan terms.
Why? The larger the down payment you contribute to your auto purchase, the less your lender will then need to cover. The smaller the remaining loan, the less of a risk the bank is taking on… and in turn, the more likely they are to offer you competitive loan terms.
2. Lower Interest Rate
The interest rate you’ll pay on your new car purchase is heavily reliant on three factors: your personal credit score, the borrowing rate set by the Federal Reserve, and the level of risk that the lender is taking on. You don’t have any control over the Fed’s interest rate, but you can build a good credit score and help mitigate your lender’s risk.
As mentioned above, the larger your down payment, the lower your loan-to-value (LTV) ratio goes. This represents a lower level of risk for the lender, which can encourage them to offer you a lower interest rate in response. If you’re not getting the rates you want when loan shopping, try increasing your down payment.
(Keep in mind that you can always refinance your auto loan down the line for a better rate, if you simply can’t get the rate you want right now. Refinancing can save you money each month and over the course of your repayment by lowering your APR, your monthly payment, or both.)
3. Lower Monthly Payment
Your auto loan’s monthly payment is calculated based on the total loan amount and your loan’s repayment term, or the length of time you will have to pay back the debt. The math is simple here: the lower your total loan amount, the lower your monthly payment will be over the course of the loan.