How does down payment size affect your auto loan?

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Once you’ve found the right car for your needs, whether new or used, the next step is finding good financing—unless you can pay for the car and any other costs with cash, of course. Typically, the loan process includes making a down payment. Read on to learn more about what exactly a down payment is and how its size can make an impact on your car loan.

 

Related: Extended car warranties: Are they worth it?

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What is a down payment on a car loan?

In auto loan terminology, a down payment is cash that you put up front toward a vehicle’s purchase price when you’re financing it. Basically, it’s similar in function to the down payment you might make on a home, with the goal being to lower the amount you have to finance. Although some lenders will finance a vehicle without a down payment (more about that later), there are benefits to putting one down for the potential borrower, too.

How much of a down payment should you make on a car?

The answer to that depends on a lot of factors. Those can include the following.

  • How much you can comfortably put down
  • Whether you’re buying a new car or a used one
  • What programs the lender is offering
  • What your credit score is

Given that situations vary, a basic rule of thumb is to put down at least 20% on a new car purchase and 10% on a used one. As you’re fine-tuning your decision, it may help to consider the potential benefits of making a down payment.

Benefits of a bigger down payment

How does increasing the size of your down payment impact your auto loan? Although not all lenders require a down payment, putting one down can result in several benefits for you, including the following.

Streamlines loan approvals

When deciding which loans to approve, lenders consider how much risk they’re taking with each particular approval. When a borrower doesn’t make a down payment, the lender is taking on more risk overall and will have more to lose if the borrower defaults on the loan. Even if the lender repossesses the vehicle and re-sells it to recoup the loss, it may not make up the full cost of the debt because, as soon as a car is driven off the dealer’s lot, it begins to lose value. With that context in mind, it makes sense that a down payment can help to reduce a lender’s risk. That, in turn, likely makes the lender more inclined to approve the loan. Plus, a dealer may offer special programs with a bigger down payment (but be sure that you’re clear about all of the details).

Lowers monthly payments

Next question: How does the down payment affect the loan amount? How does that benefit the borrower? Obviously, if you pay money upfront, your loan amount goes down. But it’s good to understand how much that can impact your monthly payments. Here’s how it works. Let’s say that you bought a $35,000 car and the lender is offering a 4% APR for five years (60 months).

 

If you don’t make a down payment and didn’t trade in a vehicle, the monthly payment will be $645. But if you put down $5,000 (in any combination of cash and trade-in), the payment goes down to $552, which would save you $93 monthly. If you put down $10,000? The monthly payment is then $460, which would save you $185 per month. So, you can see that the amount put down can have a significant amount on the payment.

Reduces interest paid back

Besides reducing the monthly payment, having a bigger down payment/lower loan amount means that you’ll pay back less interest over the life of the loan. To illustrate, here are dollar amounts for the three examples shared above:

  • No down payment: $35,000 loan amount / 4% / 60 months: $3,675 in interest
  • $5,000 down payment (14.29%): $30,000 loan amount / 4% / 60 months: $3,150 in interest
  • $10,000 down payment (28.57%): 25,000 loan amount / 4% / 60 months: $2,625 in interest

Plus, if you’re wondering whether the down payment affects the interest rate on car loans, the answer is “yes,” it can, depending on what loan programs a particular lender offers. For many lenders, a lower loan-to-value ratio (the amount of the loan compared to the car’s value) can lower the interest rate they’ll offer.

Gets ahead of depreciation

Vehicles can lose 20% or more of their value annually so if you don’t make a significant enough down payment, you could end up owing more on your vehicle than its value as soon as you leave the dealership. When that happens, it can be challenging to trade or sell your car later on.

What if you’re unable to make a down payment?

Perhaps you’ve been convinced by the benefits of making a down payment but you just don’t have the money. Is there anything you can do instead to try to avoid problems like owing more on your loan than your car is worth? There are a few strategies. Possibilities include the following.

  • Buying gap insurance: If your vehicle gets totaled, this kind of insurance will help you fill in the gap between what you’re given by your insurance company and what you still owe the lender.
  • Buying new car replacement coverage: In this case, if the vehicle gets totaled, you’d get a replacement vehicle. In some cases, this may already be part of your car insurance policy.
  • Choosing a less expensive vehicle: With a lower payment, you might be able to free up cash for a down payment.

How to save for a down payment

If you can defer your purchase, you may also want to consider taking some time to save up for a down payment. Strategies you might consider include the following.

  • Come up with a goal. Figure out how much money you’d like to put down on a car purchase. Then assess how much you think you can put toward it each month.
  • Start a budget. If you don’t have one already, this can be a useful tool to help you track and control the money going in and out.
  • Start a special down payment account. This can make it easier to keep the funds separate from your other money and see them growing.
  • Reduce spending. Get rid of unused memberships or redundant subscriptions, for example. And try to avoid large purchases, at least until after you have your down payment in hand.

Used car vs. new car down payments

In general, new cars are more expensive than used ones (although a basic new automobile can be less expensive than a fully loaded luxury vehicle that’s used). That said, typically, it’s best to put down at least 20% on a new car purchase and 10% on a used one. That may be in the form of cash, a vehicle you trade in, or a combination. When making a decision between a new or a used vehicle, note that loans on used ones typically come with higher interest rates because their value may be harder for the dealer to estimate.

The takeaway

Ideally, putting down a nice-sized down payment can come with plenty of benefits, depending on your situation. So it can sometimes make sense to take advantage of them. That said, not everyone is in a position to do so and there are other options, including car loans that require no down payment.

 

Learn more:

This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.

 

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More from MediaFeed:

Income-contingent repayment plan explained

 

Income-contingent payment (ICR) plans are one kind and can help make federal student loan payments more affordable. The income-contingent repayment plan allows you to extend your loan repayment period while reducing monthly payments to help them better align with your income. Any remaining loan amounts due at the end of your ICR plan term may be forgiven.

 

An ICR may be a good fit if you’re just starting your career and aren’t earning a lot of money. You may also consider an income-contingent repayment plan if you’re hoping to qualify for federal Public Service Loan Forgiveness (PSLF).

 

But is an ICR plan right for you? And what are the pros and cons of income-contingent repayment? Weighing the benefits alongside the potential downsides can help you decide if it’s an option worth pursuing managing your student loan debt.

 

RelatedHow to get out of student loan debt: 6 options

 

designer491/istock

 

Income-driven repayment plans, including ICR, set your monthly payment amount based on use your household size and income. Depending on how much you make and how many people there are in your household, it’s possible that you could have no monthly payment at all.

 

Like other income-driven repayment plans offered by the Department of Education (DOE), an ICR plan aims to make it easier to keep up with federal student loan payments. With income-contingent repayment, your monthly payments are capped at the lesser of:

  • 20% of your discretionary income
  • What you would pay on a repayment plan with a fixed payment over the course of 12 years, adjusted for your income

Of the four income-driven repayment options, income-contingent repayment oldest plan and the only one that sets the payment cap at 20% of discretionary income. With income-based repayment (IBR), Pay as You Earn (PAYE) and Revised Pay As You Earn (REPAYE), monthly student loan payments max out at 10% of your discretionary income.

 

The interest rate for an ICR plan stays the same for the entirety of the repayment term. The rate would be whatever you’re currently paying for any loans you’ve consolidated or the weighted average of all loans you haven’t consolidated.

 

DepositPhotos.com

 

Income-contingent repayment can reduce your federal student loan payments, allowing you to pay 20% of your discretionary income each month or commit to making fixed payments based on a 12-year loan term.

 

You have up to 25 years to repay all loans enrolled in the plan. If you still have remaining payments after 25 years of monthly payments, the DOE will forgive the balance. But while you may not owe any more payments on the loan, the IRS considers student loan debts forgiven through ICR or another income-driven repayment plan to be taxable income, so you may owe taxes on it.

 

Income-contingent repayment plans always base your monthly payment on income and family size. This means that if your income, or your family size, changes over time, your monthly payments could change as well. By comparison, if you’re enrolled in the 10-year Standard Repayment Plan, your monthly payments would be the same for the entire repayment term.

 

Here’s an example of what your payments might look like on an ICR plan versus a Standard Repayment Plan, assuming you’re single, make $50,000 a year, get 3.5% annual raises, and owe $35,000 in federal loans at a weighted interest rate of 5.7%:

1. Standard

  • First month’s payment: $383
  • Last month’s payment: $383
  • Total payment: $45,960
  • Repayment term: 10 years

2. ICR Plan

  • First month’s payment: $319
  • Last month’s payment: $336
  • Total payment: $49,092
  • Repayment term: 12.4 years

3. Savings

  • First month’s payment: $64
  • Last month’s payment: $47
  • Total payment:  -$3,132
  • Repayment term: -2.4 years

As you can see, an income-contingent repayment plan would lower your monthly payments. But it would take you longer to pay your loans off, and you’d pay more than $3,000 more in interest charges over the life of the loan. If you start earning more while you’re on the ICR plan, your payments could also increase.

 

If you get married, and you and your spouse file your taxes jointly, your loan servicer will use your joint income to determine your loan payment. If you file separately or are separated from your spouse, you’ll only owe based on your individual income.

 

Photobuay / istockphoto

 

Anyone with an eligible federal student loan can apply for the income-contingent repayment plan. Eligible loans include:

  • Direct student loans (subsidized or unsubsidized)
  • Direct consolidation loans
  • Direct PLUS loans made to graduate or professional students

Other types of federal student loans may also be enrolled in income-contingent repayment plans if you consolidate them into a Direct loan first. For example, you could use an ICR plan to repay consolidated:

  • Federal Stafford loans (subsidized or unsubsidized)
  • Federal Perkins loans
  • Federal Family Education Loan (FFEL) PLUS loans
  • FFEL consolidation loans
  • Direct PLUS loans for parents

The income-contingent repayment is the only income-driven repayment plan option that allows you to include loans taken out by parents. So if you borrowed federal loans to help your child pay for college, you could enroll in an ICR plan (after consolidating your loans) to make the payments more manageable.

 

Two types of loans are not eligible for income-contingent repayment or any other income-driven repayment plan. Those include:

 

•  Private student loans
•  Federal student loans in default

 

If you’ve defaulted on your federal student loans you must first get them out of default before you can enroll in an income-driven repayment plan. The DOE allows you to do this through loan consolidation and/or loan rehabilitation. Either one can help you get caught up with loan payments and loan rehabilitation will also remove the default from your credit history.

 

istockphoto/demaerre

 

Income-contingent repayment is just one option for paying off student loans, and it may not be right for everyone. It’s important to look at both the advantages and potential disadvantages before enrolling in an ICR plan.

 

 

fizkes / istockphoto

 

  • Can lower your monthly payments
  • Parent loans are eligible for income-contingent repayment, after consolidation
  • Extends the loan term out to 25 years to repay student loans
  • Remaining loan balances are forgivable
  • Qualifying repayment plan for PSLF

 

William_Potter / istockphoto

 

  • Other income-driven repayment plans could result in a lower payment
  • Taking longer to repay loans means paying more in interest
  • If your income changes, your payments could increase
  • Enrolling certain loans requires consolidation first
  • Forgiven loan amounts are taxable

If you’re interested in an income-driven repayment plan, it may be helpful to do the math first to see how much you might pay with different plans. An income-based repayment option, for example, might lower your payments even more than ICR so it’s worth running the numbers through a student loan repayment calculator.

 

DepositPhotos.com

 

Income-contingent repayment plans are something you might consider if you have federal student loans. With an ICR plan, you can tailor your payments to your income, making it easier to follow your budget from month to month.

 

But an income-driven repayment plan won’t reduce the interest rate you pay on your student loans. That’s something you can do, however, with student loan refinancing.

 

When you refinance student loans, you take out a new loan to pay off your existing ones. If you’re able to secure a lower interest rate on the new loan and don’t extend the term length of the loan, you could pay less in total interest over the life of the loan while having lower monthly payments. This could give you more breathing room in your budget.

 

That said, the interest rate isn’t the only factor to consider. Refinancing federal loans into private loans forfeits the protections and privileges that federal student loans provide, such as the ability to enroll in an income-based repayment plan or access to some forbearance or deferment programs.

 

Learn more:

This article originally appeared on SoFi.comand was syndicated by MediaFeed.org.

 

SoFi Student Loan Refinance
IF YOU ARE LOOKING TO REFINANCE FEDERAL STUDENT LOANS PLEASE BE AWARE OF RECENT LEGISLATIVE CHANGES THAT HAVE SUSPENDED ALL FEDERAL STUDENT LOAN PAYMENTS AND WAIVED INTEREST CHARGES ON FEDERALLY HELD LOANS UNTIL THE END OF JANUARY 2022 DUE TO COVID-19. PLEASE CAREFULLY CONSIDER THESE CHANGES BEFORE REFINANCING FEDERALLY HELD LOANS WITH SOFI, SINCE IN DOING SO YOU WILL NO LONGER QUALIFY FOR THE FEDERAL LOAN PAYMENT SUSPENSION, INTEREST WAIVER, OR ANY OTHER CURRENT OR FUTURE BENEFITS APPLICABLE TO FEDERAL LOANS. 


Notice: SoFi refinance loans are private loans and do not have the same repayment options that the federal loan program offers such as Income-Driven Repayment plans, including Income-Contingent Repayment or PAYE. 


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