When buying a new car, one of the decisions you have to make is how much you should put down. Conventional wisdom says you should put down at least 20% of the purchase price as a down payment when financing a new car. In this case, conventional wisdom is correct.
As soon as you buy a new car it depreciates dramatically. Often this depreciation is between 20% and 30% of the purchase price. That means that you are instantly “upside down” in your loan from the moment you sign on the dotted line. A hefty down payment can minimize or eliminate the discrepancy between what you owe and what the car is worth.
Consider this example:
You purchase a car for $20,000 and as soon as you drive it off the lot, it becomes worth $16,000. If you put down a 10% down payment of $2,000, your loan amount would be equal to $18,000. You would be upside down on your loan to the tune of $2,000. If, however, you put down a 20% down payment of $4,000 your loan amount would be equal to $16,000—equivalent to the car’s worth.
When you’re upside down on a car loan it complicates matters if you want to trade your car in. But being upside down is most problematic if you have an accident in which your car is totaled. A standard car insurance policy will only pay for the car’s actual cash value, which would be less than you owe. As a result, you could end up owing your lender money for a car that has been destroyed. You can purchase gap auto insurance to cover the portion you are upside down in your loan, however, for an added cost.
Putting down a significant amount on a new car also reduces how much your pay in monthly payments because it reduces the loan amount. In some cases it may also reduce your interest rate by as much as 0.5% because lenders see a high down payment as a sign that you are serious about the loan and unlikely to default. With a larger down payment you end up paying less in finance charges and may be able to pay off your loan sooner. Use the Auto Loan Calculator from BankingMyWay.com to crunch the numbers and see how adjusting the down payment affects the monthly payment and total interest paid.
In the aforementioned example, assuming a 48-month auto loan at 6.013% (the current national average for a 48-month new car loan according to BankingMyWay.com) with a $2,000 down payment you would end up paying $422.81 a month and $2,294.88 in total interest. With a $4,000 down payment, you would paying $375.83 a month and $2,039.84 in total interest.
When purchasing a used car or leasing a new one, the circumstances are different. A used car will not depreciate as rapidly as a new car, so a high down payment is not as necessary to prevent an upside-down situation. Choosing a higher down payment will reduce your finance charges and monthly payment, however, regardless of whether the car is new or used.
With leasing, you should opt for no down payment (or cap cost reduction). If you put money down on a lease and the car is totaled in the first few months, that money is gone for good. Even gap insurance doesn’t cover it. It’s better to put that money towards your higher monthly payments.
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