How Much Should You Save For A Car Loan Down Payment?
Buying a new vehicle is not an easy task. For most Canadians, the purchase of a new car is one of their biggest investments. In fact, it is the second biggest investment for many Canadians, besides the purchase of a new home.
With the right car loan in Toronto, you can successfully finance one of the most expensive purchases of your life.
Therefore, you must do your research to make the right decision.
To help you navigate the world of car loan down payments, we’ve put together this handy guide to everything you need to know. Read on to find out more!
What Is A Car Loan Down Payment?
When purchasing a car on credit, one of the first questions that you need to ask yourself is: how much should I save for a down payment?
A down payment is the upfront amount that you must pay in order to get a loan. Lenders typically ask for a down payment to reduce their risk and curtail their losses in case of default.
By making a generous down payment to your car loan provider, you are indicating to them that you will pay the full amount of the loan in time. A down payment shows your sincerity and sense of responsibility. It gives plenty of confidence to the lender in your ability to make regular on time repayments for your car loan
With a 20 percent down payment, you can win the trust of the lender and maximize your chances of obtaining a car loan in Toronto at the most lenient terms and conditions.
For those with a poor credit rating, a 20 percent down payment may be an absolute necessity to qualify for a car loan.
It is generally a good idea to make a down payment even if the lender does not require it. This can improve your chances of winning the most favorable terms and conditions on the car loan, as well as lowering your monthly repayments
What Is the Right Down Payment Amount?
After selecting the perfect car, you must think about the down payment that you must make to the lender for getting a car loan.
You may have heard that a 20 percent down payment is the optimum amount. For most cases, this amount is just right.
If you can afford it, then you should make a 20 percent down payment on your new automobile. For used cars, you should aim to pay no less than 10 percent of the loan amount as down payment.
As you will soon discover, you will enjoy several advantages with a 20 percent down payment on your new automobile.
If your financial situation is not perfect, you may find it difficult to pay this amount. If you are finding it hard to raise this amount, then you should try your best to pay an amount which is as close to this figure as possible. There are a range of benefits to this, such as lower interest rates and more favorable terms and conditions.
Although 20 percent is the ideal figure of down payment, many people pay a smaller amount. The main reason for this is that the average price of cars has increased considerably while average earnings have not increased at the same rate. Due to the large increase in the cost of cars, a 20 percent down payment is a considerable amount.
Average Down Payment
In 2014, the average price of a new car was $33,000. Buyers of new cars made an average down payment of only $3,502 during the same year. This is just 11 percent of the average price of new automobiles.
The reason for this is simple. A six grand down payment is a hefty amount which many buyers are not willing to make.
According to Edmunds, in 2017, the average down payment amount on car loans was 12 percent. This figure has gone up slightly from the 2007 value of 9.9 percent. However, the prices of cars increased 23 percent during the same time period. A 20 percent down payment would amount to around $6,000. Most people simply cannot afford such a large amount.
Benefits of 20 percent Down Payment
Here are the benefits that you can enjoy with a 20 percent down payment on your new car:
- You will gain the trust of the lender and get better terms on the car loan, such as a low interest rate.
- A generous down payment can maximize your chances of loan approval. A 20 percent down payment is strongly recommended for those who have low credit ratings.
- Your monthly repayments will be lower. You will also pay a smaller amount of total interest for the loan.
- The amount of equity in your car will be greater. You will feel a greater sense of ownership.
- You will not owe more than what the car is worth. This is very important since it will prevent you from servicing an upside down loan.
- If you pay a higher upfront amount, you will have to repay a smaller percentage of the loan. Therefore, there will be less of a burden on you.
To give you a better idea of the benefits, here are the details:
Lower Interest Rate
By paying a significant upfront amount, you can prove to the car lender that you are a responsible borrower. You are showing your commitment to a timely payment of the full loan amount. The lender will see you as a low-risk client and give you the benefit in the form of a lower interest rate.
Since car loan down payments are upfront and immediate, they don’t carry any interest. You will have to pay interest only on the remaining amount of the loan. Therefore, a substantial down payment means that you have paid a large amount of the loan interest-free.
Significant upfront payments can reduce the amount of total interest that you will have to pay.
Improved Prospect of Loan Approval
If you do not have an excellent credit rating, then you should try to make a large down payment in order to maximize your chances of car loan approval.
You should also keep in mind that you don’t need to pay the entire upfront amount in cash. You can also make the down payment through a trade-in car or a cash rebate on the purchase of your car.
If your credit rating is good (that is, below the excellent range), then you should aim to put down at least 15 percent up front for the loan approval.
Keep in mind that if your credit rating is less than excellent, then you can possibly face higher interest rates and tougher terms and conditions. This is because a good credit rating represents a greater risk as compared to excellent rating. With a high down payment, it may be possible to lower the interest rate and monthly payment amount.
Reduced Monthly Payments
When you make a large down payment, you will have a smaller debt burden.
As a result, you will have to pay a smaller remaining amount over the lifespan of the loan. This means smaller monthly payments.
Consequently, your take-home pay will be more.
You will enjoy greater equity with a larger down payment.
A larger down payment is highly desirable for cars in particular since they usually have a big depreciation rate.
Depreciation is about 20 percent in the first year. With a 20 percent down payment, you are essentially offsetting the first year depreciation amount.
You can increase your equity this way.
Avoid the Upside down loan Situation
An upside down loan can occur if you owe more than the true value of your car. This can easily happen if you make a small down payment on your car.
You may hear about dealerships that offer loans on zero down payments. While it may appear to be an attractive offer, it involves high risk and major disadvantages.
If your purchase is financed 100 percent by your car loan, then you will end up owing more than what your car is worth. This is because your loan will include several amounts, such as the purchase price, tax, interest and various fees. In short, if you don’t pay an upfront amount, then the true worth of your car will be lower than the amount that you owe.
This is a financially perilous situation. Those who face this scenario are said to have gone ‘underwater’ or ‘upside down’ on their loan.
If you are underwater or upside down, you may be unable to trade in your vehicle if you are trying to purchase a new automobile. In some situations, you may be allowed to trade in your old car if you pay off the full amount of the loan.
A major risk is that if your car is completely wrecked, the insurance company will not pay more than the cash value of the car. As a result, the full amount that you owe may not be covered.
What about Smaller Down Payments?
While a 20 percent down payment is the best way to proceed, there may be situations in which you can consider smaller down payments.
Low Interest Rate
If you are careful about market conditions, you can keep your debt levels under control.
You should ask: is it economical or expensive under the current scenario to borrow money? You will have to pay close attention to the interest rate.
When the interest rates are high, you must pay as much cash as possible for the down payment. This will keep your loan amount to the lowest level possible and minimize the total interest that you must pay.
But when interest rates are low, it might make sense to make a smaller down payment. Under the condition of low interest rate, you can take out the full loan amount even if you have enough cash to make a large down payment. You can invest your cash at a high interest rate from which you can earn income. You can use this income to offset the interest, which you will have to pay on the loan.
Purchasing Used Vehicles
As mentioned earlier on in this article, smaller down payments are usually made when purchasing used vehicles. When purchasing a second-hand vehicle, a smaller down payment can offer you a key benefit.
You will need to set a reasonable budget for your second-hand automobile. You must have cash at hand for repairs and car maintenance. Repair and car maintenance expenses may not be substantial for the first few years of a new automobile. But they can be significant for used cars.
With smaller down payment, you will have enough money in your pocket for maintenance and repairs of your used car. You may have to spend a significant amount on your second hand car even if the previous owner took good care of it.
In order to avoid costly repairs during the first year of ownership, you should avoid private sales. You should search for used vehicles at reputable dealerships. They will have cars that are in good condition.
The Bottom Line
The best strategy in most situations is to make a 20 percent down payment. This will offer you several advantages.
But under some circumstances, (for instance, when interest rates are low) you may obtain greater benefit by taking out the full loan even if you have a large amount of cash in hand. You can then invest this cash at high interest to earn income. This income can be used to pay off the interest incurred on your auto loan.
Smaller down payments are better for purchasing used vehicles.
Since the prices of cars have increased considerably over the years, car loans are now a necessity. According to Experian, almost 90 percent of customers purchase a new car with auto loans. For used cars, more than half of all customers apply for a car loan to finance their purchase.
For the best car loans in Toronto, you should contact the largest specialty auto loan company in Canada.
Auto Loan Solutions
3200 Bloor Street West
Toronto, ON M8X 1E1
Toll Free: 866-467-8945