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Do I Need a Down Payment?

downpaymentApplying for an auto loan doesn’t necessarily require you to make a down payment but doing it is highly recommended. We will lay down the pros and cons of making a down payment so you can have a well-informed decision on what to do when making an auto loan.

What is a down payment?

First off, a down payment is an initial payment made to cover the difference between the cost of your vehicle and the amount of financing received. To cite an example, if you plan to buy a $25,000 car and finance $20,000 of the said price, a $5,000 down payment is needed to close the gap. Usually a down payment is made in cash but there are also other alternatives in how you can make a down payment.

For instance, you can trade-in your existing car and the dealer will make an assessment regarding of its value. After they have assessed the value of your car, it can then be counted as a down payment. Take note, that the Canadian Black Book value of your car may be more than what the dealer will offer. So always be mindful of the value that the dealer will give you. Selling your car personally beforehand and using the cash earned from that sale as a down payment might prove to be more advantageous for you.

What is the purpose of a down payment?

If there is a possibility that you can obtain full financing for the total amount of your vehicle why not take it right? Others might immediately say yes but there are risks and benefits to this offer. So make you decision wisely.

Risks

It can cause major problems such as the potential to become “upside down” on your car loan. This happens when the car is costing you more money than what it is actually worth. To remind you, a vehicle loses its value or depreciates by almost 20% as soon as you drive off the dealership. Going back to our example, a $25,000 car will depreciate down to just $20,000. A more precise way of calculating depreciation can be made by dividing the trade-in value of your car after one year of ownership by the original price. Therefore if you avail 100% financing, you would still owe $25,000 for a car that is only worth $20,000.

The same situation applies when you have an accident or if when you need to sell your car. In an unfortunate car accident, most insurance companies will only reimburse you the current value of the car and not the purchase price. Likewise, selling your car will only give you a relatively fair price, not the original purchase price. This is one of the greatest risks of no-down payment loans.

Benefits

Looking at the brighter side, having a down payment can minimize risk and even save you money. How? First off, a down payment can provide near-immediate equity giving you the option to trade-in your vehicle for a new one without costing you too much money!

Secondly, lenders are more comfortable in borrowers who can make a down payment because it shows commitment on the part of the borrower. Additionally, it will also minimize risk for the lender since he is also lending a smaller amount of money. Furthermore, it can also likely lead to a situation in which the lender will provide a better interest rate thus saving you hundreds if not thousands of dollars. Looking back, combining an improved interest with a smaller amount of loan will surely save you a significant amount over the term.

How much money should your down payment be?

       The most recommended value for a down payment is 20% in order to cover the initial depreciation of your newly bought car as you leave the pavement. Despite that, nowadays average car buyers place down less than 20% specifically averaging around 12% last 2013. There are two possible reasons as to why car buyers have opted to pay a relatively low down payment than what is recommended. First, the cost of purchasing a new car has significantly increased faster than the average. Secondly, national economic policies have encouraged financing by maintaining low interest rates in order to promote global economy recovery from the late 2000’s financial crisis.

       On the other hand, car buyers can also choose to buy secondhand cars in order to minimize financial risk since they will be paying a much lesser price than brand new cars. Experts say that a down payment of 10% is already enough to protect yourself when choosing to buy a secondhand vehicle. GAPinsurance is another alternative that ensures you against the difference between what insurance companies pay you when in an accident/stolen car and the remaining debt that you owe your lender.       

       Increasing your down payment or even paying out straight cash may prove to be the right decision for others but every situation is unique. If you have extra cash, you have the choice of investing it in a car or in a business (i.e. stocks). Unlike a house and lot, the value of a car depreciates as years go by thus it is wise to consider your financial status and stability before agreeing to make a purchase.

Making a down payment is one thing and getting the right financing is another. Here are some key points that you need to consider so you can choose the best deal for you.

  1. The Lender. Establishing connections with a lender that understands you and your needs is a game changer. It will save you from a headache and will also let you choose a deal that best suits you. Like buying clothes in a mall, taking your time to look for the best lender will surely pay off. Unlike banks, dealerships are often more inclined to extend credit to potential buyers since they have added bonus of selling a car. To add, they have a better understanding about the local economy and are more sympathetic in terms of local hardships such as large-scale job layoffs.
  2. Down Payment. As mentioned earlier, making a down payment is more advantageous for you as a buyer than not making a down payment since it reduces the total amount that you need to finance. Financing a portion of the asking price leads to lower monthly payment. Moreover, agreeing to shorter loan duration will lead to less overall interest to the lender but it also means having to pay a higher monthly payment since the total amount is divided by fewer months.
  3. Credit Scores, Interest Rates and Loan Duration. A high credit score can give you the awesome opportunity of enjoying the best interest rate (as low as 0.00%) especially for those with highly exceptional credit scores. Generally, the interest rate that you will receive depends upon your personal financial/credit history as well as other factors such as economic policies. Bear in mind that an interest rate does not account the total finance charge of your loan. It is the Annual Percentage Rate (or APR) of your auto loan that fully shows the total expenses that you will incur expressed as annual rate. An APR includes documentation fees, filing fees, warranty charges and the likes.

      The loan duration and interest rate influence the amount of monthly payment you will need to pay.

Specifically, a lower interest rate means lesser interest payments but at a cost of higher monthly payments if you choose a shorter loan duration. Meanwhile a longer loan duration means lower monthly payments but a higher interest rate – thus greater overall cost. Let us give you a clearer breakdown:

  1. Interest rate is higher because it means extended risk for the lender.
  2. There is greater overall expense because of paying monthly interest over a longer period of time.
  3. Monthly payment is smaller for long term loans because you are dividing the total amount by a larger number of months.

Most car purchasers are tempted with the allure of a low monthly payment while not realizing the overall added thousands of dollar in interest. That is why it is always important to take your time to look at the bigger picture. This can save you a significant amount of money.

Normally, auto loan durations take 36,48 or 60 months to finish. Some loans even take as long as 72 or 84 months however these terms are avoided at all cost. When will long term be an advantageous option? If you have a current stable income but an uncertain future then long term deals may work in your favor. If you can pay off your loan while you’re still financially stable then do so. But later on, if your income declines, you will only have lower monthly payment taking less burden off your shoulder.

Another important thing to remember when choosing a long term auto loan is that you should pick a vehicle that is sturdy and reliable. This will ensure you that your car can last as long as the duration of your term.

When not paying a down payment is better

       Life can be as unpredictable as the weather so when it comes to financial planning you must always expect for sudden emergencies. Even thousands worth of saving can go down the drain if not managed properly. That is why there are instances in which choosing not to pay a down payment is the better choice. Situations such as:

  1. Your existing vehicle cannot be used anymore
  2. Personal transportation is really needed
  3. You don’t have the money to pay a down payment
  4. Ready to assume possible risks of making a car loan without down payment in order to save your current money for more immediate needs such as medical expenses or college tuitions for your kids.

Take note that as mentioned earlier, no downpayment is way more difficult to manage and is highly risky for you as a borrower. Lenders can also add erroneous fees and added costs making your life miserable. That is why it is always wise to be patient and save up funds even just for a small down payment. It safeguards you from being upside down on a loan and even unfair lending practices.

When you have decided what financial plan you are going to take, get in touch with us and take a moment to fill out our credit application.