Save money on your car loan by building up a solid nest egg.
Most car loan providers and dealerships recommend that you make some sort of a down payment when buying a car. A substantial down payment not only helps you qualify for a lower interest rate, but it decreases the overall cost of your loan and prevents you from owing more than your car is worth.
How much should I spend on a down payment?
The general rule of thumb is putting down 20% of the price of the car up front.
While some dealerships and lenders might allow you to put as little as 10% down — or less, in some cases — the closer you get to 20%, the better. This is because a larger down payment reduces the amount you owe on your car loan, saving you thousands of dollars on interest in the long run. No-down-payment car loans tend to have higher interest rates and will simply cost more because you borrow more.
However, don’t get too caught up in all of these rules. The average down payment on new and used cars in 2019 was around 11.7%, according to an analysis conducted by Edmunds. Your down payment should be realistic based on your lifestyle and budget — especially if you plan on buying a used car that won’t depreciate as drastically.
Look at your savings, the interest rate for your credit score and the type of car you’re buying to help inform how much you put down. While 20% is a great goal, even a small down payment is better than none at all.
How can I calculate my down payment?
Calculate your down payment by taking the price of the car and multiplying it by the percentage you plan on putting down.
For example, say you want to buy a used car for $16,000 with a down payment of 20%.
You’ll multiply the sticker price by 0.2 — the decimal value of 20% — which gives you a total down payment of $3,200.
You can then subtract the down payment from the total cost of the car to see how much you need to borrow: $12,800.
Finally, you can use our monthly payment calculator to see how much you’ll pay in interest over the life of the loan based on different rates and terms.
Can I trade in my old car to help increase my down payment?
Yes. While you’ll still want to save money for a down payment, you can also count your old car’s trade-in value toward your total down payment. So if you saved $1,000 and your old car is worth $1,500, you’ll have a total of $2,500 to use as a down payment.
However, if you’re looking to get the most bang for your buck, you might want to consider selling your car to a private party yourself instead of trading it in at the dealership. Dealerships tend to buy trade-in cars at wholesale value, which is often less than the price you could get from a private buyer.
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6 benefits of making a large down payment on your car
From lower interest rates to increased equity, making a larger down payment can help you save in both the short and long term.
1. Lower interest rates
Having a decent-sized down payment can help you snag a lower interest rate for two reasons:
- You pose less risk to the lender. A down payment shows you’re committed to your purchase and demonstrates your ability to save. Because of this, some lenders may be willing to extend a lower interest rate.
- You have to borrow less money. Typically, the smaller your loan amount — the lower your interest rate.
2. Lower monthly payments
Having more money to put down on your car means you need to borrow less. This not only makes for smaller monthly repayments, but also means you won’t have to pay as much in interest over the life of your loan.
3. Higher chance of loan approval
If you don’t have the best credit, a larger down payment may help you qualify for a car loan. Typically, banks and credit unions want to see that you have around 15% of the car’s value saved up when you have a credit score that just barely meets the minimum requirements.
But you don’t necessarily need it all in cash. Many lenders are willing to count cashback rebates and the trade-in value of your used car toward your total down payment amount.
4. More equity
When you buy any car — new or used — you need to account for depreciation. New cars are especially prone to it, with many losing around 20% of their value within the first year of being driven. Since this money is practically lost, having a large down payment ensures you aren’t stuck with a car loan so large that you end up paying more for your vehicle than it’s actually worth.
Used cars have a little more wiggle room. Since they only lose about 10% of their value every year, you may be able to reduce your down payment and still maintain equity. However, because used car loans tend to have higher interest rates than new car loans, you may still want to make as large of a down payment as possible to decrease how much you have to borrow.
5. Avoid becoming upside down on your car loan
Becoming upside down on your car loan means you owe more on the vehicle than it’s worth. Not only will you be paying more on your loan than you’ll be able to sell your car for, but you may also have to roll the remaining amount into a new loan if you decide to buy a different car. This can cause you to become trapped in an endless upside-down car loan cycle.
Having an upside-down car loan is especially dangerous if your car is totaled and you don’t have gap insurance. Without it, you’re responsible for covering the difference between what your insurance company will pay and the outstanding balance on your car loan.
6. Less cost overall
Perhaps the biggest benefit to making a large down payment on a car is the money you’ll save by not taking out a larger loan. Yes, both your interest rate and monthly payments will be lower. But you’ll also owe less overall — putting you in a safer financial position.
You can then take that money you would’ve been paying in interest and put it toward other goals, like paying down debt or investing. Even a few extra hundred dollars will add up over the three to six years you spend paying off your car.
Bottom line
Making a sizable down payment on a new or used car can help you qualify for a lower interest rate and lead to lower monthly repayments. Plus, you avoid running the risk of becoming upside down on your car loan.
Once you’ve built up your savings, compare your car loan options to see what rates and terms you may be eligible for.