Car Loan Down Payment Size

Anyone who has ever bought or sold a new car knows about depreciation.  When you buy a new car, it loses about 20% of its value almost immediately.  Right away, then your car loan is upside down.  The best way to combat this is with a bigger down payment at the time of the purchase.

A down payment is just another tool you can use to lower your monthly payments, decrease the life of the loan, and help you qualify for a lower car loan interest rate.  A larger down payment also sends a message to the financial institution that you are willing to put more of your own capital into the transaction.  It will also help ensure that your loan doesn’t remain upside down for long, if at all.

A loan is said to be upside down when the remaining balance to be paid exceeds the value of the car.  In simpler terms, you could owe $20,000 on a car that’s only worth $17,000.  This is much more of a problem with real estate loans than car loans, but it is still a situation you should strive to avoid. 

It’s almost unavoidable that a car loan ends up upside down, especially at the very beginning of the loan.  Depreciation is to blame for that.  The trouble you’ll end up in is when you remain upside down for more than a couple of years of the term.  The value of the car keeps going down, but the car loan remains the same.  This will negatively affect you if/when you decide to trade the car in.

Most people make the mistake of rolling their remaining balance into the loan for a new car.  This just means you’re still paying for the car you don’t have anymore, and probably paying more interest than before.  Not good.

The best way to avoid that situation is to either avoid buying a new car until the old one is paid, or make a substantially heftier down payment on the new one.  The second option is usually the most effective of the two, and here’s why.

Most car buyers will put down between 4% and 8% on a new car.  That isn’t much of a down payment- it is usually barely enough to pay for sales tax and titling fees.  A weightier down payment will also offset the depreciation of the vehicle and result in much more manageable car loan with a better car loan interest rate.

A smart option for beefing up your down payment is to shoot for roughly 20% to 30% of the purchase price.  At that rate, assuming the car remains in decent shape, you’ll be back right side up almost immediately.  That’s not bad on a four or five year car loan.  If that’s too much cash for you, get as much as you can and put as much down on the car as possible.  This will shorten the terms and lower your car loan interest rate and total interest payments.

Tags: car buying, car loan interest rates, car loans

This entry was posted on Friday, February 20th, 2009 at 5:09 pm and is filed under Articles. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.