Few purchases in life will give you a greater sense of mobility or freedom than buying a car. And a reliable set of wheels is an essential investment for most areas of the United States.
But like any investment, the stages of buying a car can cause analysis paralysis. And the question of just how big a down payment should be has stumped many a driver.
Now, you’ve probably heard the old chestnut that 20% is ideal. But at the same time, you’ve also heard of $0 down deals and people paying cash (i.e., a 100% down payment).
So which is it? How much should your down payment on a car be, and why?
Before we discuss down payments, spend a minute with my Car Affordability Calculator to find your budget. Once you have a budget in mind, let’s talk about what percentage of that number to put down.
TL;DR 20% on a new car, 10% on a used car
While 20% of a vehicle’s retail price is an ideal down payment amount for both new and used rides, 10% will do just fine for used vehicles.
So why the difference?
Why are new and used different?
Depreciation.
Studies show that brand new cars tend to lose around 50% of their value within five years and 20% after the first year alone. Certain cars — like luxury or sports cars — tend to lose that 20% as soon as you drive them off the lot.
So, let’s say you buy a brand new 2023 Acura for $40,000 and put just 10% down, or $4,000. Your loan amount will be $36,000.
A few months later, the car is worth just $32,000 and your remaining balance on the loan is still $34,000. You’re now $2,000 underwater on the loan, meaning if you have to sell the car in case of emergency, you’ll still owe your lender money.
Being underwater sucks, which is why putting 20% down is a smart move. It keeps you “above water.”
Why does a good down payment matter?
Let’s look at all the reasons making a solid down payment can make life much easier for you down the line.
Keeps you within budget
Auto dealers love to advertise “$0 down, 0% APR” deals because they love tricking shoppers into buying cars they can’t really afford. After all, auto loans are secured loans, meaning if you don’t pay, your lender can just come and take the car back.
Lowers your monthly auto payment
The next benefit of a higher down payment is that it reduces your monthly payment.
If you tinker with our handy Auto Loan Calculator, you’ll see that buying a $20,000 car with 10% down and a 7% interest rate leads to a monthly payment of around $460 (assuming a 48-month term, which is the longest we recommend).
However, if you can afford it, doubling your down payment to $4,000 will reduce your monthly payment by nearly $50. And that really adds up over time.
Lowers total interest paid (and possibly even your rate)
Lenders make money by charging you interest. If you borrow less money or you borrow for a shorter amount of time, you pay less in total interest.
In the example above, doubling your down payment on a $20,000 car from 10% to 20% also saved you nearly $300 in interest.
And if you make a larger down payment, your lender might also drop your interest rate overall from, say, 7% to 6%. In that case, you’d save hundreds more on interest.
Lowers your chances of going underwater
As mentioned above, a higher down payment means you’ll spend less (or zero) time underwater on your loan.
If you put 10% down on a new $20,000 car, in a month it could be worth $16,000 while you still owe $17,700 on it. But if you put 20% down, you’ll owe under $16,000 and stay above water.
Potentially saves big on auto insurance
Auto lenders require you to have full coverage auto insurance for the lifetime of the loan (i.e., collision, comprehensive, and liability rolled together).
On average, full coverage auto insurance costs around $1,853 a year. But if you were to downgrade to liability-only, you’d pay just $650 a year (again, on average).
So, if you make a larger down payment, you’ll be able to pay off your loan faster and gain the option to downgrade your coverage from full to liability-only. On average, this could save you around $1,200 a year in auto insurance alone.
Protects your credit score
Your credit score is made up of five different metrics:
- Payment history
- Credit utilization
- Length of credit history
- New credit, and
- Credit mix
Assuming you make every payment on time, an auto loan can actually improve all five dimensions. A bigger down payment can help even more by keeping your credit utilization in check and reducing the risk of missed payments.
Increases your odds of loan approval
Finally, your lender may require a bigger down payment to begin with.
Lenders use a metric called the loan-to-value ratio (LTV) to determine your terms on an auto loan. The LTV is simply the amount you want to borrow divided by the value of the car.
For example, if you want to borrow $16,000 to buy a $20,000 car, that’s an LTV of 80%.
Lenders reward low LTVs with better interest rates. Some even have caps on LTVs based on your credit score (Good = 80%, Excellent = 90%, etc.).
So if you have a credit score below 700, you might need to make a high down payment to lower your LTV and get a loan.
Should I just pay cash for a car?
Now, all this begs the question: If a higher down payment is better, why not pay cash?
When we start talking about cash down payments above 20%, the conversation changes from one about risk to one about opportunity cost. In short, you’re committing cash that you could otherwise be growing in the stock market.
But before I get ahead of myself, let’s talk about the pros and cons of paying cash.
Pros of paying cash for a car
You can save on interest, insurance, and stress.
If you pay cash for a car, it’s yours. You don’t have a monthly payment, you don’t need full coverage unless you want it, and perhaps best of all, you’ll have one less bill to worry about.
It’s also faster. No need to apply for six loans and listen to the dealer prattle on about their financing department. Just cut them a check and drive off.
All that sounds great, right? But let’s consider the cons of cash as well.
Cons of paying cash for a car
Your investments could outpace your interest rate
Let’s say you’d like to buy a $20,000 car, and you’re debating whether to finance it or pay for it in cash.
If you take the $20,000 you would have used to pay for the car in cash, and instead invest it in an index fund with a historical average of 9% in annual returns, after four years that $20,000 you invested would be worth $28,628.11, per our investment calculator.
Simultaneously you take out a loan to pay for the car at 5% for 48 months, with a $4,000 down payment. With these loan terms you’ll ultimately pay about $23,000 total for the car (loan payments and down payment combined).
$28,628.11 – $23,000 = $5,628.11 in profit that you would have missed out on had you paid for your new ride in cash.
Now, there are obviously a few caveats to this:
- Auto loan interest rates can vary considerably from year to year, and you won’t always be able to get a super-low rate, even with an excellent credit score.
- Historical average returns on any investment aren’t guaranteed.
But even still, if you can secure an auto loan interest rate around 5%, you’re probably better off investing that money versus paying cash.
Where should I pull the cash for a good down payment (savings, investments, etc.)?
Finally, if you don’t have enough cash in your checking account for a good down payment, where should you pull the dough from? Savings? Investments?
In general, it’s best to pull from checking or savings since that money a) isn’t growing fast or at all, and b) won’t trigger fines or taxes for being withdrawn.
But if you can wait and start piling up paychecks, do that.
FAQs
What is a good down payment for a car?
A good down payment on a car in most situations is 10% on a used car and 20% on a new car.
What is the average down payment on a car?
The national average down payment on a new car was $6,026 in Q1 2022, on an average $47,077 purchase price for new vehicles. That’s a 12.8% average down payment.
Used car down payments averaged $3,574 during that same period, on an average $33,341 purchase price for used vehicles. That’s a 10.7% average down payment.
Can you buy a car with no money down?
Yes, technically you can buy a car with no money down. But your loan terms will be terrible (if you’re offered a loan at all) and you’ll be underwater on your loan on day one. In other words, don’t do it.
Can I make a down payment on a credit card?
Yes, you can make a down payment for a car on a credit card. The main benefit of this approach is that you can potentially earn a lot of cash back or rewards points, depending on which credit card you use.
However, keep in mind that the dealer might charge you a 3% transaction fee for using a credit card, which would obviously negate, say, 1.5% in cash back rewards. And if it maxes out your credit card it could hurt your credit score.
Still, it might make sense if you’re trying to make the minimum spending requirement for a special sign-up bonus, and/or you want to take advantage of your credit card’s 0% APR period.
Summary
In the end, the old adage “if you can’t afford the down payment, you can’t afford the car” rings true. The silver lining to saving your pennies a little while longer is that prices have nowhere to go but down.
In the meantime, now that you have a budget and a down payment in mind, let’s find the perfect car and help you get the price down even further. Check out my guide: How to buy a used car (and get a good deal).
