Auto Finance Guide: Size of your down payment

We all know that a new car loses a significant amount of its value when you drive it off the lot. That's where the down payment -- the amount of cash you bring to the purchase -- comes in.

The down payment can demonstrate to a lender that you're willing to make an investment in the deal, and perhaps gain a more favorable interest rate. It also helps take some of the shock out of the instant depreciation so you're not "upside down'' on your loan for years and years.

Upside down

What's it mean to be "upside down?'' You learned in an earlier chapter that it's the industry term for a car owner who owes more on a vehicle than it's worth. Almost every new car -- and most used-cars -- transactions involve a period of being upside down on the loan. After all, if you put 10 or even 20 percent down on a car and it depreciates 25 percent in the first three months, you're upside down, at least for awhile.
But where it gets worrisome is when the owner remains upside down three and even four years into a loan.

You've also seen earlier how some folks make matters worse by rolling the old car's remaining debt into a new loan. They're forced to pay interest and make payments on a car they don't even own anymore. And tacking the extra debt on their new auto loan puts them upside down all over again.

Up the down payment

How do you avoid that situation, aside from making the best initial purchase deal possible and not rolling your old car's loan into the deal?

Make a substantial down payment.

These days, the average down payment for an auto loan isn't much of a payment at all. A typical car buyer puts just 5 percent down. That often doesn't even cover the cost of sales tax and other fees, much less make a dent in the depreciation factor.
If at all possible, a buyer should plan on putting down at least 20 percent of the purchase price. With that much down, a buyer should begin to see positive equity about two years into a four-year loan, assuming the vehicle's kept in good shape.
If you can't put down 20 percent, scrape up as much cash as you can and keep the term of the loan as short as possible.