How Much Down Payment for a Car Do You Need? Your Questions Answered
Before walking into the dealership, take time to understand how much down payment you need for a car and how the financing process works.
Contributing Writer at Tally
June 28, 2022
Purchasing a vehicle can be a complex process. Researching a new car, pulling your finances together and walking into a dealership can all be daunting. However, it’s something most of us will do in our lifetime, considering that 91.55% of households have access to at least one vehicle.
Before walking into the dealership, it’s important to do your homework. This primarily means having your finances in order.
One of the most significant financial aspects of buying a car is the down payment. A down payment is a sum of money that you pay at the onset of the purchase. It is typically expressed as a percentage of the total purchase price.
This article answers many frequently asked questions regarding down payments and auto purchases. We’ll start by explaining what a down payment is and then answer the questions, “How much down payment for a car is needed if it’s new?” and “How much down payment for a car is needed if it’s used?”
We’ll then answer questions regarding the importance of down payments, the payment options you have when purchasing a vehicle and what you can expect from the purchasing process.
What is a down payment?
A down payment is a sum of cash that you pay upfront when financing a new purchase, like a car. Down payments are typically expressed as a percentage of the total purchase price.
For instance, let’s say that you are going to purchase a new vehicle for $40,000. You decide that you are going to pay $4,000 at the onset of the purchase. Upon doing so, you will have made a 10% down payment toward the vehicle purchase.
Your outstanding balance on the vehicle is now $36,000. You may seek to secure an auto loan to cover this cost. This is known as “financing.” We’ll dive into the specifics of financing in the sections below.
How much down payment for a car is needed if it’s new?
If you’re purchasing a new vehicle, it’s recommended that your down payment amount equal at least 20% of your purchase price. The reason is that 20% will typically offset your car’s first-year depreciation. Edmunds describes depreciation as “the amount by which the value of a vehicle declines from its purchase price to its estimated resale value.”
Cars depreciate around 10% when you drive them off the lot. By putting at least 20% down, you lower the risk of having an upside-down car loan — in that case, you owe more to your lender than your car’s value.
This could become a significant problem if you were to be in an accident and your car was totaled. The payment from your insurance company would likely be worth the cash value of the vehicle, which may not be enough to pay off the amount you owe on the car’s loan.
Let’s say, for the sake of example, that you put zero down on a $40,000 vehicle. You’re in an accident within the first week of ownership. Because you put zero down, your loan amount is $40,000.
Accounting for the 10% depreciation that occurred as soon as you purchased the car, your insurance company estimates the cash value at $36,000. You still owe $40,000 to your lender, but you’ll only have $36,000 cash from your insurance company. You also need to secure another car.
This example is a bit extreme, but it illustrates why it’s important that your down payment amount covers your first-year depreciation. You could look into gap insurance to cover the difference between what your vehicle is worth and what you owe to your lender. However, gap insurance is another expense, as you’ll have to pay premiums and potentially a deductible.
If you put a large down payment on your car, you may be able to avoid having to purchase gap insurance. Your lender can help you determine whether this is true based on your financial situation and the vehicle you’re purchasing.
How much down payment for a car is needed if it’s used?
If you’re buying a used car, you’ll want to consider putting down at least 10% of your purchase price. Depreciation is not as rapid with used cars, so you can afford to put down less money. A 10% down payment should cover your first-year depreciation on a used car.
Do you have to make a down payment?
Generally, you don’t have to make a down payment. But some lenders may have stipulations that require borrowers to put down at least some amount of money before financing.
Even if it’s not required, based on the information provided above, it’s a good idea to consider making a car down payment when you’re purchasing a vehicle.
Besides preventing you from becoming upside down on a loan, you may also find that a down payment can help in other areas. Though it varies from lender to lender, a down payment can potentially:
Lower your loan-to-value ratio: Lenders have loan-to-value ratio thresholds that they abide by. If you have a low credit score, a larger down payment can help you fall within one of those thresholds, thereby helping you secure financing. Essentially, a lower loan-to-value ratio increases your borrowing power.
Lower your interest rate: Putting more money down upfront can help improve your loan terms. A good rule of thumb is that the more you put down, the lower your interest rate will be, since a large down payment from a car buyer signals less risk. The lower your interest rate, the less interest you pay over the life of the loan.
Lower your monthly payment: A larger down payment will also result in lower monthly payments over the life of your loan. This can make it easier to fit your car payments into your budget. You can use an auto loan calculator to see how a larger down payment will impact your monthly payments.
What payment options do you have when purchasing a vehicle?
When you’re ready to purchase a vehicle, you have a few options:
Pay 100% in cash
Pay a down payment and finance the remaining amount
Put down zero money upfront and finance the entire amount
The more money you put down upfront, the more money you will save in interest.
How does purchasing a vehicle work?
There is a general blueprint of steps to take when purchasing a vehicle. Below is a high-level overview of what you can expect and how to put yourself in a good financial position:
Research the cars you’re interested in purchasing. Look into things like pricing, safety features and deals in your area.
Know your trade-in value. If you are exchanging one vehicle for another, know your trade-in value before going to the dealer.
Secure preapproval. Shopping with outside lenders for the best interest rate and loan terms gives you an idea of how much you can afford. It also allows you to compete with dealer financing.
Visit the dealer. Look at your potential purchase and take it for a test drive. Ask for out-the-door pricing so that you know exactly how much you’ll be paying for the vehicle. Out-the-door pricing includes things like dealer fees, titles and taxes. Also, be sure to ask about any promotional pricing and warranties that come with the vehicle.
Do more research. Compare the dealer’s price to the market price for the car. A tool like the Edmunds price checker can help.
Purchase the car. This is where you’ll need to pay your down payment and sign on to a loan. Don’t be afraid to negotiate pricing with the dealer as well.
Understanding car financing can help you in the long run
The process of purchasing a vehicle can be challenging. Not only do you have to research the types of cars you’re interested in, but you also have to pull your finances together.
Before walking into the dealership, you’ll want to have a reasonable idea of how much you are going to pay for the vehicle, what the trade-in value is on your current car, how you are going to pay for your new car purchase and the amount you are going to put toward a down payment.
Some lenders may not require you to make a down payment, but doing so may help you receive a lower interest rate on your car loan, thereby reducing your monthly car payment. If you put down a substantial down payment, you may even be able to forgo gap insurance.
If you need help getting your finances in order, be sure to consider Tally†. Tally is a credit card payoff app designed specifically to help you pay down debt quickly and efficiently while also managing your due dates. Taking the time to get your personal finances in order may help when you are ready to purchase your next car.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.