Should You Make a Down Payment?

What is a down payment? It's the money you pay upfront at time of purchase on a vehicle you are financing. Cash Due at Signing is a similar payment made when leasing a vehicle. Depending on your credit score and history, many lenders will require down payments. However, even when it’s not required, it may be a good idea to put some money down anyway. That’s because making a down payment can result in you ultimately paying less interest, having lower monthly payments and keeping you from being "upside-down" on a vehicle.

A down payment is calculated as a percentage of the vehicle’s value or purchase price. If you’re buying a $35,000 car and make a 10% down payment, the down payment would be $3,500 at the time of sale. This down payment can be paid with cash, by trading in your current vehicle or a combination of both.

One reason lenders want you to make a down payment is to show your commitment to paying back the loan. A down payment also allows the lender to receive some compensation for the vehicle upfront, thereby reducing their financial risk.

Making a down payment can reduce your monthly payments and result in less interest paid over the life of the loan. The more money you put down for a vehicle. the less money you have left to pay back.  With a smaller loan amount, you’ll pay interest on a lower balance, which means your total interest cost will be less, too. For example, if you took out a five-year $35,000 car loan at 5% APR interest rate, you’d pay a total of $4,629.59 in interest, and your monthly payment would be $660.49.  If you made a 20% down payment ($7,000) on the same car, you’d pay only $3,703.67 in total interest, with a monthly payment of $528.39.  You end up saving almost $1,000 in interest and have a monthly obligation that is over $130 less.

Another reason to put some money down at the time of purchase  is that some lenders offer better loan rates with a down payment. This is due to the fact that  your loan-to-value ratio — the amount borrowed versus the value of the car — is a factor that affects your interest rate. A down payment can also help you qualify for an loan more easily, especially if you don’t have the best credit score. Without a down payment, the lender has more to lose if you default on your loan. On the other hand, you have more to lose if you default on your loan, since you're invested a larger amount of money.

Dealers also often offer special financing or leasing programs with lower rates or other incentives if you make a down payment when financing, or pay a cash amount at signing on a lease. This can result in lower monthly payments that help you better manage your ongoing budgeting. Also, when dealers advertise special incentives, they’re required to clearly disclose the terms. So you know in advance if a down payment will help you qualify for a special offer.

While there are many benefits from making a down payment not all of us are in a position to afford it. If you find yourself in this situation, there are a couple of things you may take advantage of to help protect your finances.

Consider purchasing gap insurance. Gap insurance helps you offset the difference between what your insurance would pay for your vehicle if it’s totaled, and what you still owe on the car.

Alternatively, you can purchase new car replacement coverage. This type of insurance lets you replace a new car that’s totaled with a new one… usually one that is the same make, model and with the same equipment. If you don't have either gap insurance or new car replacement coverage, your insurance pay-out will likely only equal the vehicle’s cash value at the time it was totaled and not what you originally agreed to pay for it at the time of purchase because of depreciation.

In summary, by making a down payment on a vehicle, you can save money and improve your chances of getting a loan. But, if you don't make a down payment on your vehicle, it may be a good idea to consider gap insurance or new car replacement policies in order to cover depreciation in the event your vehicle is totaled.