Will a Cash Downpayment on a Car Help with Financing?

You can more easily obtain financing for a car if you make a cash down payment. Cash down payment or not, you still have to qualify for the loan, and your income and credit score have a major impact on your qualification. If you can qualify for a loan, making a down payment saves you money in the long term.

Credit And Income

Lenders usually require you to have a credit score of 620 or higher in order to take out any kind of loan, and people with scores lower than that have so-called "subprime" credit scores. Very few lenders finance car purchases for subprime borrowers, and those that do charge high fees and interest rates. Additionally, you must have enough income to manage the car payment and your other debts. Your lender calculates your debt-to-income (DTI) ratio by looking at your gross income and your existing monthly debts. If you have a DTI ratio above 50 percent, you cannot usually qualify for a loan.

Depreciating Collateral

Cars are a type of depreciating collateral, which means that the value of a car drops over the course of time. Lenders attempt to structure your loan so that you pay down the balance faster than your car can lose value. Nevertheless, once you add interest into the equation, lenders find it very hard to prevent your car value from dropping below your loan balance. Consequently, some lenders only allow you finance 80 percent of the value of a car, and when this happens, you have no choice but to make a cash down payment of 20 percent.

Gap Insurance

Some lenders do allow you to finance up to 100 percent of the value of a car, but to protect the lender against losses stemming from an accident, you are required to buy gap insurance. Normally, if you crash your car, the insurer only gives you a payout that equals the car's value, and this often amounts to less than the balance of the loan. Gap insurance covers the difference between the car's value and your loan balance. However, gap insurance causes your monthly payment to rise, which makes the loan harder to obtain due to the high payment amounts. Therefore, a cash down payment eliminates the need for gap insurance and makes it easier to obtain a loan because you have a lower payment amount.

Considerations

If you make a $2,000 cash down payment toward a $10,000 car purchase, then you save yourself from having to pay interest on that $2,000 for the duration of your car loan term. If you buy an expensive car with a high interest loan, you can save a significant amount of money by making a cash down payment rather than financing the entire amount of your loan. Therefore, cash down payments benefit both lenders and borrowers.