How is Down Payment Decided When You Buy a Car?

how is down payment decided when you buy a new car

What is a Down Payment?

A down payment on a car is a percentage of the vehicle’s total cost that you will pay upfront during purchase. For example, if you are buying a car for Rs 10 Lakh, then a 20 percent down payment on the car will amount to Rs 2 Lakh. Usually, this is paid for in cash by the buyer. Another option would be to exchange your used car at the dealership if it makes up the down payment cost. That way, you will not need to deplete your bank savings.

Recommended Down Payment on a Car

A 20% down payment will cover the vehicle’s depreciation cost, which amounts to almost 20-25% during the first year of ownership. If you make a 20% down payment and then sell the car within the first year, you will owe more for the car than its total worth. So paying for the depreciation cost upfront can get you a lower interest rate on the loan. 10% of the car’s cost will also suffice realistically as a used loses its original value through depreciation.

Things to Know Before Deciding on a Down Payment for a Car

Now that the 20% of the car’s cost is being covered by the upfront cash from the buyer, the remaining 80% cost will have to be financed another way. It so happens that some buyers can afford the cash directly. But for the majority, the rest of the amount will be covered through a loan.

The size of the down payment affects the loan as it will interfere with many factors such as the interest rate, the amount of your monthly payment, and the length of the loan. The larger the down payment, the more palatable the rest of the loan terms will become.

Zero% Down Payment

Some dealerships offer zero down payments for some brands and models which mean that you may not have to pay upfront cash to buy the car. However, it is always beneficial to the buyer to pay a per cent of the cost as a down payment as it offers numerous benefits.

A 0% interest loan costs you nothing more saving you from emptying your bank account. You save a lot of money in terms of loan interest.

However, even with a 0% interest car loan, in case of an unfortunate accident, the car is deemed a total loss by the insurance company we could end up owing more than the car’s actual worth. So if the funds are available, making the 10% – 20% down payment would be the safer choice than risking it.

Car Loan

The higher your down payment, the lesser you need to borrow from the bank. This means that you can repay your loan faster and also pay less money in monthly instalments. So a better down payment makes handling the loan easier in the long run.

Say, for example, you are set to buy a car worth Rs 5 Lakh with a 5-year loan tenure period. If your down payment is Rs 1 Lakh, then your loan will amount to Rs 4 Lakh which needs to be paid in full within the 5 years along with its interest. But instead, you pay Rs 2.5 Lakh upfront, then your loan requirement also decreases to Rs 2.5 Lakh which can be paid off easier than the previous case. At the end of your tenure, this would have significantly reduced the amount you are required to pay every month as equated monthly instalments (EMI).

Loan Tenure

The tenure period of the loan is an important factor to be decided when you are applying for a car loan. A loan that is agreed to be paid over a larger number of years will only demand less EMI from you every month. But if your down payment is significantly higher, then your financial requirement itself would be way less and will let you settle the loan much earlier than someone who pays a very low amount as a down payment. The sooner you pay off the debt, the lesser the interest.

However, a big down payment and the same EMI for the same loan tenure will let you buy a pricier car if you’d like to. You may not have to settle for a base variant of your favourite model.

Now, for an easy understanding of this, let us say you want to buy a car for Rs 3 Lakh this time. Without upfront payment, you would take a loan for the whole cost of the car, say, for 5 years. But with Rs 1 Lakh down payment, you could bring down the loan tenure to 3 years with the payment of the same amount as EMI.

Similarly, for the same case as above, let’s say you can pay a maximum amount of Rs 5,000 for the maximum loan tenure available. Then, you can only get a car for Rs 3 Lakh without the down payment. But if you are able to make the upfront Rs 1 Lakh and still do the payment of the same Rs 5,000 as EMI, you can get a car for Rs 4 Lakh which means you have bumped up the line for the next higher variant.

Interest Rate

Most banks approve your car loan faster if they see you making a large amount as a down payment. This shows that their risk is less on loaning you the rest of the cash for the car. A larger down payment also helps if you have a bad credit score already. As a result, your total loan amount will reduce by a greater margin and thereby reducing the rate of interest you will be required to pay.

Since a big down payment means a lower loan amount, it also means a reduced term of a loan. The interest rate is compounded throughout the entire loan tenure. Hence, the reduction in the term will amount to a lesser amount to be paid as interest. Also, a smaller car loan can make you eligible for a lower interest rate.

Now that you know how a down payment for purchasing a car affects various financial factors, you can decide how much to put down for the car of your dreams.

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