Conventional wisdom says that a good down payment for a car is about 20% of its total price. That’s because cars typically lose about 21% of their original value the first year. The logic was that if something happened to the car, it wouldn’t necessarily total your finances as well. If, for example, you had a $500 deductible, you’d be out the deductible plus the difference between what you owed and what the car’s value was before an accident.
But as vehicle prices have risen, it has become increasingly difficult to come up with 20% down. The average transaction price reached $31,773 in 2013, according to Edmunds.com. That translates to an eye-popping $6,355 if you want to plunk down 20%. And most people don’t go car shopping with anywhere near that much cash available to put toward their car.
The potential difference between a car’s value and what you owe is less of a worry now, as insurance providers have developed products to address it. Gap insurance covers the difference between a car’s value and amount owed. And some insurers have a new-car replacement benefit, which pays for a new car of the same make and model if your vehicle is totaled in an accident during the first year of ownership. These products can make it less risky to make a smaller down payment.
Edmunds consumer advice editor Ron Montoya said that when people get ready to finance a car, they generally do something that is both understandable and dangerous: They focus on the monthly payment. With a smaller down payment, monthly payments are higher. Most people have a comfort zone for car payments, and getting the payment lower requires either a higher down payment or a longer term. And it’s a lot easier to agree to an extra year of payments than it is to come up with additional money at the last moment. We do it not so much because we like making car payments, but because that’s the only way to make the new car fit into our budgets.
Another factor that can reduce your payment — or add to it — is your credit score. The lowest interest rates go to customers with a proven track record of handling credit well (this calculator can show you how much your credit score affects your cost of debt over time). And so if car financing is in your future, it’s a good idea to find out what potential lenders will see when you apply for a car loan. It is also smart to pull your credit reports to make sure the information there is accurate, because your credit scores are derived from the information in your credit reports. You can see two of your credit scores for free on Credit.com and find out how your credit history is affecting them.
Statistics tell the story of how we’re making decisions about car financing. We put down about 12% of a new car’s drive-out price. And we finance for an average of 66 months — six months longer than what Edmunds recommends as the maximum term. We stretch out payments because that’s the only way to make the new car fit into our budgets.
Montoya doesn’t recommend doing it that way. If you can’t pay a new car off in five years, he recommends that you look at a less expensive car (new or used) or consider leasing.
Leasing can be a good option, he said, particularly for people who don’t plan to keep their cars for much beyond the payment period. It also requires a much lower down payment. Montoya sees society in general becoming more comfortable with paying for use rather than ownership (When was the last time you bought a movie to watch at home, for example?) He said leasing can get you a brand-new car for about $200 a month. And the down payment, he said, should be as low as you can negotiate. You’ll have a slightly higher monthly payment by doing it that way, but you should keep in mind that you won’t be getting any of your down payment back — it just costs you more to drive the car home from the dealership.
More on Auto Loans:
- Are There Car Loans for People With Bad Credit?
- What to Do If You Can’t Make Your Car Payments
- Top 5 Worst Car Buying Mistakes
Image: Ridofranz
You Might Also Like
Getting a new car is a big decision, and you should choose your n... Read More
October 20, 2020
Auto Loans
According to the Consumer Financial Protection Bureau, around 2.3... Read More
July 20, 2020
Auto Loans
