It’s common to apply for an auto loan and be required to put some money down to get everything rolling. But who gets the down payment?
Buying a new car is an exciting experience. But when you sit down at the dealership to finalize your purchase, you may be surprised when the salesperson asks you to put money down upfront. This is a common practice in the auto industry, but many car buyers don’t fully understand the reasons behind it. In this article we’ll explore why car dealerships require down payments and how it impacts your overall auto purchase.
What is a Down Payment?
A down payment refers to the lump sum you pay upfront when financing a major purchase like a home or automobile. For cars, it’s typically a percentage of the vehicle’s total cost that you pay before driving it off the lot. The remaining balance is then financed over the term of your auto loan.
Down payments for cars often range from 10% to 20% or more. But some dealers advertise “$0 down” financing. While putting zero down is possible, it’s not always the best approach, as we’ll discuss shortly.
Why Do Dealers Want Down Payments?
There are several key reasons why car dealerships push buyers to put money down
Reduces the Dealer’s Risk
For dealers who arrange outside financing, a down payment shares some of the lending risk with the third-party lender. If the customer stops making payments, the lender takes a smaller loss because a portion was prepaid upfront. This makes lenders more willing to approve buyers who put more money down.
Improves Chances of Loan Approval
By reducing the amount financed, a larger down payment can help buyers with poor credit or low incomes get approved Since the overall loan amount is lower, monthly payments will be more affordable too.
Earns Interest
Dealers that offer in-house financing can earn interest on down payments. Depending on local laws, they may require non-refundable deposits which allows them to use your down payment between the time you sign the paperwork and take delivery of the vehicle.
Closes More Sales
Putting cash down shows a serious commitment to buying. Once customers make a down payment, they are more emotionally invested in the purchase. This makes them less likely to shop around further or walk away from the deal.
Covers Tax & Fees
Sales tax, registration, and documentation fees are due when you purchase a car. A down payment covers these costs upfront so they don’t get lumped into the loan amount. This prevents your monthly payment from being inflated.
How Much Should You Put Down?
While any amount can work, financial experts typically recommend the following down payments:
- New Cars: 20% or more of the purchase price
- Used Cars: 10% to 20% of the purchase price
So for a $30,000 new car, strive to put $6,000 down or more. For a $15,000 used car, try to put between $1,500 and $3,000 down.
Putting extra money down is wise if you can afford it. You’ll end up with more equity, reduce interest costs, and have lower monthly payments. Just be sure you still have savings leftover after making your down payment.
Can You Buy a Car With $0 Down?
Some dealerships advertise “zero money down” or “no down payment.” While tempting, this isn’t always the wisest approach. With no down payment:
- Your loan amount will be higher, raising your monthly payment
- Interest charges over the loan term increase
- If the car gets totaled, you have no equity built up
- Getting approved with bad credit is less likely
However, $0 down deals can make sense if you have excellent credit or plan to pay off the loan quickly. Just know that zero down often means higher long-term costs in most cases.
Other Down Payment Considerations
Here are a few other things to keep in mind regarding auto down payments:
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Shop for the best rates and negotiate the selling price regardless of your down payment amount. Don’t let dealers use your down payment to avoid giving you their best offer.
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Avoid “non-refundable” deposits if possible. Only forfeit your deposit if you’re 100% sure about the purchase.
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Consider having the dealer apply your down payment towards reducing the car’s purchase price, rather than just putting it towards the loan. This prevents miscommunication.
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Calculate estimated sales tax and fees ahead of time so you know how much extra to put down beyond just the down payment percentage.
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If you’re receiving a trade-in allowance, decide whether to apply it towards your down payment or subtract it from the vehicle purchase price. Run the numbers both ways to optimize the deal.
The Bottom Line
While zero down sounds tempting, it’s smart to put some money down when purchasing a new or used car. A higher down payment typically works in your favor by making financing easier, reducing interest costs, and building immediate equity. Evaluate your budget carefully and put down as much as you can reasonably afford. This will lead to lower payments and long term savings.
How Much Should I Put Down?
There’s an old car-buying rule called the 20/4/10 rule. It states you should put down 20% of the vehicle’s selling price, finance the car for no more than four years, and that your loan payment, auto insurance costs, and monthly vehicle expenses shouldn’t be higher than 10% of your monthly income.
This old standby rule is falling out of practice lately, due to the rising price of new cars. However, the 20/4/10 rule has good roots that bad credit borrowers can learn from.
Heres how the 20/40/10 rule applies to financing:
20% Down – Benefits of a Large Down Payment
By having a substantial amount of cash to put down on a vehicle, you’re doing multiple things. First, you’re lowering your monthly payment. Secondly, you’re lowering your interest charges (which is very important to many bad credit borrowers). And thirdly, you’re increasing your approval odds because your total financed amount is less.
4 Year Term – Benefits to a Short Loan Term
Auto loans almost exclusively use a simple interest formula. As a borrower, this means the longer the loan term, the more you pay over time. A simple interest formula means your interest charges accrue based on your remaining loan balance, rate, and length of the term. By choosing a shorter loan term, you’re saving money because you’re paying off your loan faster. If you’re expecting to get a less-than-ideal interest rate, consider a shorter loan term to lessen how much you’re going to pay the lender over time.
10% of Income – Monthly Vehicle Expenses
Vehicle expenses don’t just include your car payment – it includes your auto insurance premium, cost of gas, repairs, regular maintenance, tires, oil, and more. Don’t be a payment shopper and only care about your monthly loan payment. Be sure to consider all the other costs of owning a vehicle, and remember that you’re required to have full coverage auto insurance when you finance, which is typically around $100 a month.
Where Down Payments Go
If you’re buying a vehicle from a dealership, any cash down or trade-in equity that you want to use is put toward the car’s selling price. This means the dealership takes the down payment and it knocks down how much you need to finance with your auto lender.
Want a car for $20,000 and you’re required to put down 10% of the price? That’s a $2,000 down payment requirement, and now you only need to finance the vehicle for $18,000.
You may be thinking, “But if auto lenders don’t get the down payment, why do they require it?” Good question.
It’s because down payments provide security to the loan, lower your monthly payment, and prove to the lender that you’re willing and able to invest in your own success. By bringing money to the table (also called having skin in the game), you’re essentially telling the lender, “I’m ready and willing to repay this loan because I’ve invested a good amount of money into the vehicle already.”
If you have poor credit, it’s very likely that you’re going to need a down payment to qualify for a car loan. Since a less than perfect credit score can make a lender question your ability to repay borrowed money on time, they often require a bad credit borrower to front some cash to lower the odds of the loan falling into default.
Borrowers that have a down payment typically have a higher chance of completing the loan successfully and making their payments on time. One of the biggest factors of auto loan eligibility is your ability to repay the loan on time – and with cash down, you’re increasing the chances of being able to do just that.
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FAQ
Why do car dealerships require a down payment?
Is it illegal for dealerships to ask for a downpayment?
While there are some myths circulating that claim otherwise, car down payments are perfectly legal. Popular social media platforms have spread misinformation, often causing car buyers confusion at auto dealerships. In fact, down payments are an effective way to reduce your loan amount – and your credit burden!
How much should you put down on a $27,000 car?
How much do car dealers ask for a down payment?
Quick Answer. Aim to put at least 20% down on a new car and 10% down on a used car. That said, you’ll need to base your down payment on what you can afford and what makes sense for your financial situation. If you’re able to afford it, a larger down payment can lower your total loan costs.