The amount of your down payment plays an important part in the total financial calculus of buying a car. However, down payments aren't the same amount for each person. You'll want to put enough down to make a dent in your payments and total cost, but not so much that it squeezes your current finances. As a first-time buyer, you'll have to consider what interest rate and terms you can get and how those might affect how much you'll be required to put down.
Benefits of a large down payment
The main benefit of a large down payment is that you reduce the amount of money you owe on a car. The more you put down, the less you will have to finance. Since financing a car involves paying interest, you can save more money over the course of your loan if you put down a large amount.
For example, say you want to buy a car that costs $20,000. A three percent car loan over 60 months will cost you roughly $1,600 in interest. If you put down 20 percent, or $4,000, that same three percent loan over five years will only cost you about $1,200 in interest. Additionally, your monthly payment will fall from $359 to $288.
Disadvantages of a large down payment
While the benefits of a large down payment are clear, if you're running yourself into financial ruin just to make an oversized down payment you might consider something smaller. If you have to borrow to make a large down payment, or if you completely wipe out your savings to do so, the benefits of a large down payment might not be worth it. In those scenarios, you should consider either trimming your down payment down to the 10 to 12 percent range or think about choosing a less expensive car.
When you borrow money to buy a car, the lender is taking a risk that you won't be able to pay it back. To counter this risk, you might only be extended a loan with a high interest rate, or one that requires a higher down payment. As a first-time car buyer, the fact that you have no experience in paying off a car loan might also result in a request for a higher down payment, even if you have a good credit score.
To keep yourself out of financial trouble, some experts suggest that you follow the 20/4/10 rule, which says your down payment should be at least 20 percent, your car loan shouldn't extend for more than four years, and your monthly payment shouldn't be more than 10 percent of your monthly income. In an era when the average car loan extends to 68 months, sticking with the 20/4/10 rule is a prudent way to avoid the pitfalls that trip up many other first-time car buyers. It will also enhance your equity if or when your needs change, and you want to sell or trade it.
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