Reader Jimmie wrote in with a good question about the ideal down payment on a car:
I’m going to buy a new car in several months and I’m trying to figure out how much down payment I should have. I’ve heard tons of different answers from different people. What’s your take?
My initial take was to give this an off-the-cuff response. The bigger your car payment can be, the better, right?
While Jimmie’s question is a good one, there is no one-size-fits-all answer. Each situation is unique, and your ideal down payment on a car might be completely different than someone else’s.
Still, there are several steps you can take to figure out what kind of down payment would be appropriate for your situation. Here’s what I would do if I were trying to figure out how big my down payment on a car should be:
Step 1: Get Your Credit Report
The absolute first step you should take when considering a loan is to get your credit report. You can get your credit report for free from the federal government – no strings attached – at AnnualCreditReport.com. I recommend avoiding freecreditreport.com because it requires “enrollment in Triple Advantage,” a credit-monitoring service you probably don’t need.
With AnnualCreditReport.com, you can request a free credit report from all three credit reporting agencies each year. If you’ve never checked your report before, it’s worth getting all three.
Once you have all three copies of your credit report, take special care to go through them line by line to ensure accuracy. Your credit report will list all of the debts you owe, as well as credit lines currently available to you.
No matter what you do, try not to hurry this process. Go through your report carefully and make sure that every item listed is accurate. If you find any information that is inaccurate, it’s crucial that you report it to the responsible credit reporting agency right away. They can help you dispute and remove any misinformation you find on your credit report, which will improve your credit score over time. Get these issues straightened out before you move on.
Whenever you take out a loan, sign up for a credit card, or take out an insurance policy, the company you’re dealing with takes a peek at this report – or your actual credit score. Your credit score is basically just a number that summarizes all of the information in your report. Most credit scores fall between 300 and 850 – the higher the score, the better.
Why is this so important? When your credit score is relatively high, you’re much more likely to qualify for the best car loan rates. Likewise, the lower your score and the messier your report, the fewer loan options you will have. Getting a copy of your credit report is the first step toward determining your credit health and ensuring the best loan terms possible.
Step 2: Decide What Type of Car You’re Buying
To figure out how big your down payment needs ought to be, you need to decide what type of car you really want to buy. Here are a few questions to ask yourself as you begin this next phase of the process.
Are you buying used or new? Buying a new car comes with its own set of benefits. First of all, you’ll typically be covered by some type of warranty, which can lead to huge savings if your car breaks down or requires extensive repairs in the first few years.
Meanwhile, buying a new vehicle extends the length of time you’re able to own your car. If you pay off your car loan in three years, you’ll have a good seven to 10 years of payment-free car ownership ahead of you, and probably even a few years left on your warranty, too.
The problem is, buying new usually means losing at least 20% of your car’s value the second you drive it off the lot. For many people, the rapid depreciation that comes with new cars is unacceptable.
But, here’s the thing. Whether it’s because they need to hit monthly sales goals or some other motivation, dealerships usually offer the best incentives when you’re buying a brand new car. In some cases, you may even be able to get a 0% APR for the duration of your loan.
When that’s the case, your down payment may become a moot point. Likewise, you may want to consider a larger down payment if you plan to buy a used car and know you’ll end up paying interest on your loan.
What model are you buying? When you’re shopping for a new or used car, it’s always helpful to have some sort of idea of what you’re looking for ahead of time. You might find the sheer number of available cars overwhelming at first, so it helps to have things narrowed down.
Are you looking for a family sedan? A fuel-efficient hybrid? An all-wheel-drive SUV or pick-up truck? If you can narrow down your search to one or two models, or even a basic vehicle type, you can conduct the kind of in-depth research it takes to get the best deal possible.
The Internet is a treasure trove of data when it comes to comparing different vehicle types, including their features, reliability, and price points. And that’s part of the reason it helps to know what model you’re interested in before you really dig into the details.
Research and compare specific models or entire vehicle categories on Edmunds.com, or check out back issues of Consumer Reports (you can often find them at your local library) for thorough car reviews.
Once you narrow your search down to a few different models, figure out the average cost for each vehicle. Use Edmunds or Kelley’s Blue Book to look up the value of the model and year you’re looking at so you have a good idea of what you’re saving for. As a rule of thumb, the more you plan to spend, the more you’ll want to save up ahead of time.
And remember, cars are not cheap. According to Experian’s State of the Automotive Finance Market study from Q3 of 2016, the average new car loan was $29,880 earlier this year. Meanwhile, the average used car loan was still $19,101.
Step 3: Figure Out How Much Down Payment You Need
Now that you have all of this information, you’re ready to figure out how big the down payment for your car should be. Follow this decision tree:
Is your credit bad?
If your credit isn’t all that great, your car loan will probably come with terms that are less than ideal. Therefore, you’ll want to grow your down payment as big as possible before you buy. If your credit score is good, however, keep going.
Are you buying new?
If you’re buying new, you’ll probably want to put down at least 20%. That way, you won’t start off our new loan “underwater.” Even if you’re able to qualify for a loan with low APR, it still isn’t wise to owe more on your car than it is worth.
What would happen if you lost your job and could no longer afford the payments? If your loan was underwater, you wouldn’t even be able to sell your car and break even. Or what if you totaled the car and your auto insurance only paid you for the car’s fair market value, not what you still owed on it? If you didn’t pay for an insurance add-on for that situation, you’d be left owing money on a hunk of scrap metal.
With an older car, you’ll still experience some depreciation, although on a much smaller scale. However, I would still try to save up at least 10% in order to start off the new loan with some equity.
And don’t forget: The bigger your down payment, the smaller the loan you might end up with. Your monthly payment will reflect how much you actually borrowed, for better or worse. Once you figure out whether you’re buying new or used, move on to the next step.
What’s the actual best loan offer you can get?
Before you head to the dealership, stop by your local bank or credit union and check online companies to see if their car loan terms are more attractive than what you might find elsewhere. You have nothing to lose by checking, and you might get lucky and discover that your bank offers excellent terms.
Recommended Online Car Loan Companies
After you check online and with your bank or credit union, head to the dealership you plan to use to see what they can come up with. In today’s low-interest-rate environment, you should expect to pay less than 7% APR on your car loan. If the dealership and your bank can’t offer a lower rate lower than 7% APR, you should just keep saving.
Regardless, this is where having a large down payment for your car comes in handy. The more cash you have on hand, the more leverage you might have in your negotiations with the dealership. When you have 20%, 30%, or 40% saved up, you might be able to negotiate a lower sales price or better terms for your loan.
Also, remember that what you have saved for a down payment isn’t necessarily what you have to put down. If you have 40% saved up and can get an astoundingly low interest rate by only paying 20%, you don’t have to cough up that extra 20% – keep it for your emergency fund or save it for the next car you need to buy.
Here’s what you should do, summed up in one paragraph: Have at least a 20% down payment — unless you’re buying an old car, then 10% is the bare minimum. If you find that the interest rate is over 7%, save for a bigger down payment and wait until you absolutely need the car.
While I personally believe in avoiding debt and paying cash for everything, I also know that my philosophy doesn’t always translate into reality. So I offer this one little piece of advice: start saving now.
Open an online savings account and set it up so you are contributing to it on a regular basis, whether it’s once per month or on payday. The keep saving until you need a new car. Lo and behold, your down payment will be sitting there waiting for you – and the bigger, the better.