Down Payment or Zero Down? What You Need to Know

Buying a vehicle with zero down sounds too good to be true. Many dealers, banks, and credit unions do offer auto loans with no down payment. A new car with no money up front is a tempting offer but is it a good deal or a scheme to get borrowers to commit to a loan?

Most lenders require borrowers to meet strict criteria in order to qualify for a loan with no down payment. You will generally need a credit score of 700 or more to qualify. It is typical for lenders to also require proof of income which is high enough to repay the loan.

You may qualify for a zero down auto loan but is it wise to purchase a car without any down payment? There are some things you may want to consider before you choose the best options for you. Here is what you need to know.

The Truth About Zero Down Loans

Securing an auto loan without any down payment sounds like a sound financial decision but in the long term it will probably end up costing more. Furthermore, you can end up setting yourself up for a weaker bargaining position when it’s time to purchase subsequent vehicles. If you’re not careful that zero down loan can reduce your buyer power and harm your long term financial security.

Interest

Lenders don’t give out loans for free. Every loan comes with some form of interest which represents the cost of borrowing. This fee is a percentage of the principal amount and is affected by factors such as a borrower's credit score, the loan term, and current market rates.

The principal amount is how much money you borrow determines. Since this is what interest is calculated on borrowing less means paying less interest. A down payment reduces the principal amount, saving you money on interest over the life of the auto loan.

A down payment can also affect the term of your loan and give you more options. The loan term is the amount of time you will take to pay back what you borrowed. Shorter term loans tend to qualify for lower interest rates which can translate to big savings.

If you put zero down on your auto loan you will end up having a larger principal amount with more interest on it. It will take you longer to pay back, lengthening the term and possibly increasing the interest rate that a lender is willing to offer you. You end up with a bigger principal amount to calculate interest on and a higher interest percentage too.

Fees

When you buy a car you don’t just pay the sticker price. There are fees and additional costs such as taxes, registration fees, and dealership charges. If you are financing your vehicle with an auto loan, these additional costs get rolled into the loan increasing the principal amount.

Ultimately the amount of your loan will include the price of the vehicle, all the fees and charges, plus the interest your lender is charging you. What this means is that you can end up owing substantially more than the car is worth. The only way to offset these additional costs and get yourself back in the black is with a down payment.

Depreciation

New vehicles depreciate in value very quickly after purchase. Typically a brand new car can depreciate as much as 20% in the first year. With no down payment you end up owing thousands more than your car is worth as soon as you drive it off the lot.

When you owe more on your vehicle than the value of the car you are upside down on your loan. This is not a good place to be and you have no equity in your vehicle. If something happens to the car you will not be able to recoup enough money to repay your debt which means you will be paying for a car you don’t have.

What does all this mean for your zero down loan? It may feel like you’re saving money by holding on to your down payment but in exchange you end up with a larger principal amount, a higher interest rate, a longer term, and no equity in your vehicle. Having no down payment ends up costing you more while reducing your options.

What Is a Good Down Payment For Your Auto Loan?

Any down payment is better than no down payment. Whatever money you can afford to put down is that much less you’ll have to pay interest on. Additionally any down payment will shave time off your loan and allow you to build equity earlier.

If you’re saving for a down payment and wondering when you have enough for a good financial decision there is a rule of thumb you can follow. On a new car a down payment of 20% will offset the depreciation on your vehicle in the first year. Used vehicles depreciate much more slowly and a 10% down payment is a good starting point if you’re buying a pre-owned vehicle.

Don’t be afraid to put down more money if you can afford it. These figures are minimums to keep yourself right side up on your auto loan. Anything above 20% will help you get ahead and improve your financial situation.

What To Do If You Don’t Have A Down Payment

Setting money aside for a down payment is difficult for most people. There are no easy answers but there are things you can do to improve your situation and avoid making a poor decision on your auto loan. Consider all of your options before choosing what will serve you best.

If you already own a vehicle you can trade it in and use its value as a down payment on your new car. This is another reason why it’s good to have equity in your vehicle. It gives you more options when it’s time to move on to your next car.

It may not be the most popular option but consider buying a less expensive vehicle. If you are finding it impossible to save 20% of what the car you want is worth then you may be living outside of your means. Shop around for cheaper vehicles or consider buying used.

If you can delay buying a vehicle you can use that time to save up a down payment. It’s also a good opportunity to work on improving your credit score if it is lacking. Do you need that new car now or can it wait?

If you’re out of options then choose your loan carefully. Read the fine print and pick an auto loan that will allow you to pay it off early at no additional costs. This way you make it easier to refinance your loan with better terms and a lower interest rate if your financial situation improves.

Zero down loans are generally not your best bet. It may seem like you are saving at the start but you will repay that and then some throughout the life of the auto loan. Any down payment can help you build equity and save money.