The Importance of Down Payments and Interest Rates on Car Loans
When financing a car, borrowers begin to consider a number of things. For example, what’s an appropriate budget? Or, should I buy new or used? In addition, borrowers begin to think about a potential down payment on a car and search for a low interest rate on a car loan. Shopping for a vehicle and related financing takes time because you need to assess all aspects of your options. After all, car ownership usually lasts many years. It’s important that you make an informed decision. But when it comes to a down payment and interest rates, what’s more important?
In this article, we’ll explore the importance of a down payment and interest rate independently. From there, we’ll assess which aspect is more important in terms of financing a car and why.
Why is a down payment important?
A down payment on a car is important because you’re reducing the risk of negative equity, showing potential lenders you’re financially responsible, and will require a smaller car loan principal. All of these factors reduce your personal finance risk and your perceived risk in the eyes of lenders.
When financing a car, most borrowers put down between 10% and 20% of the car’s price. With that being said, making a down payment is not required by most lenders.
Why is the interest rate important?
For virtually all financing decisions, borrowers are concerned with the interest rate and how low it is. The lower the interest rate on a car loan is, the cheaper your financing decision will be. Everyone wants to finance their car as cheaply as possible which is why the interest rate is important to consider.
Which is more important?
Both the down payment and interest rate are factors that directly impact your car loan. The truth is, no component is more important than the other. It’s all relative. It’s better to think of your car financing holistically since every component interacts with each other. Let’s take a moment to consider how down payments and interest rates interact within a car loan.
The larger your down payment is, the less you will need to finance through a car loan. This means you’ll pay less interest, regardless of what the actual rate is, because your principal is lower. Also, lenders are more likely to approve your loan if you ask for a lower principal amount.
Putting down a larger sum of cash communicates to lenders that you’re financially stable and serious about your car purchase. In addition, asking for less money means less risk to lenders. This could lead to a lower interest rate, and possibly more favourable conditions, because lenders will perceive you to be financially stable.
An interest rate on a car loan tends to be lower when the borrower’s credit score is high. If you’re able to make a down payment on a car between 10% and 20%, chances are you are in a good financial position and your credit is good. By maintaining healthy finances and attending to your credit score, you can secure a great deal on a car loan interest rate.
Making Your Car Financing Decision
Realistically, when you’re shopping for a car and financing, you should consider both the down payment and interest rate, in addition to other aspects, like the loan term, conditions and car price. All the aspects of a car purchase and financing interact with one another which means you can’t neglect one aspect and place more emphasis on another aspect.
Before shopping for a new car, determine how much you can afford to put down. In addition, do what you can to improve your credit score before applying for financing, such as paying off old debts, checking for errors and paying your bills on time and in full. Using a car loan calculator is a great way to see how different interest rates and your down payment affect your monthly payments.
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