You can get a low APR car loan with little or money down (with good credit). Use savings to pay off credit cards or other debt, not as a down payment.

Buying a car, new or used, is a financial commitment. You can make a down payment, reducing the amount you’ll have to pay monthly on the vehicle. But what if you have more pressing debt, like credit card or student loan debt?

Does it make sense to sign up for a car payment plan and use the short-term cash to pay other debts first? We’ve analyzed the pros and cons of each choice.

What is a down payment on a car?

First things first, let’s get clear on exactly what a down payment on a car is. A down payment is money you pay towards the purchase price of the car upfront. It reduces the amount you will borrow for the car.

For example, let’s say the car you are buying is $15,000.  If you don’t put any money down then you will have to borrow the full $15,000.

Or you could put some money down, which would go towards the purchase price and reduce what you need to borrow.  So if you put down $5,000 you would only need to borrow $10,000.

Why make a down payment on a car?

You’ll get a better deal on a car loan

Let’s be honest, few of us can pay the full price of a vehicle out of pocket. If you make a down payment, you’ll still finance or borrow the remainder of the cost.

But the payment reduces your loan-to-value ratio—the amount of your loan divided by the cash value of the vehicle. A lower loan-to-value ratio often leads to better loan deals. You might get a shorter loan term, a better interest rate, or reduced monthly payments.

You’re less likely to go underwater

Car loan holders are considered “underwater” or “upside down” on a loan when they owe more money than the car is worth. This is also called, in less scary-sounding terms, having negative equity.

How can negative equity affect you? If the car’s stolen or totaled, or if you need to sell, you’re still on the hook for monthly loan payments. And the lower worth of the car means your insurance won’t pay enough to cover the cost. So you’re paying full price for a car you no longer have.

The shorter your loan term, the better

A larger down payment can score you a shorter loan term, reducing the amount of time you have to pay off the loan. Yes, this means you’ll pay more cash up front so you can save in the long run.

A short loan term is especially helpful because cars depreciate the minute you begin to drive them. The longer you’re paying down a car loan, the more your car’s value will drop. Once the car is depreciating faster than the unpaid loan balance is dropping, you’re in danger of going underwater. And your options will be more limited if you decide to trade in the car.

Plus, once your vehicle reaches a certain age it starts needing repairs. With a shorter loan term, you’ve paid off the car by the time you have to invest in keeping it running.

When you’re deciding on a loan term, think about the total price of the car rather than the monthly payments. Dealers will often calculate your potential rates by looking at the longest loan term possible, making the monthly payments seem much more affordable than they actually are.

You may not have a choice

Car buyers with spotty credit or no credit at all will likely have to put more money down on a vehicle.

But this can be a blessing in disguise. Not only does the down payment reduce the remaining car loan, it helps keep the car from going underwater. If your cash flow situation changes and you need to sell the car, you’ll be in much better shape if you’ve made a down payment. And the money you save can go towards other debts as needed.

How much of a down payment should I make?

The rule of thumb is to put down 20% of the value of the car. This amount is large enough to keep you from going underwater, but not large enough to make the car unaffordable.

To calculate how much a 20% down payment will be, use our car affordability calculator to figure out what you should spend overall.

When to skip a down payment or make a smaller one

Save money on interest

The main reason to skip or skimp on a down payment for a car is because the interest rate you’ll be paying on your car loan is less than you are paying on other debts.

Let’s say you have $5,000 to put down on a car and you’ll be borrowing $10,000. You have good credit and your interest rate on the car loan will be 6%.

If you also have credit card debt at 19% it might make sense to send that $5,000 to your credit cards instead of using it to make a down payment on your new car.

Build your emergency fund

If you are living paycheck to paycheck you may want to consider keeping your down payment for emergencies.

Having a healthy emergency fund can avoid all kinds of financial heartaches and is the first step to take when getting your finances in order.

Read more: Building an emergency fund – Why, how, and where to keep it

Which should you choose?

Make a down payment if:

  • You have average, fair, or poor credit.
  • Your existing debts are minor or less burdensome than a large car loan would be.
  • You’re concerned about your ability to make monthly car payments.

Pay off debt if:

  • You can get better interest rates on a car loan than you can on your existing debts.
  • You’re able to put off a car purchase until you’ve saved a little more.
  • You have great credit and a ton of auto loan options.

Summary

The best car financing plan will be different for everyone, but you can find a method that works for you. Just don’t forget the financial big picture.

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About the author

Amy Bergen Writer
Total Articles: 101
Amy Bergen is a writer and editor based in Portland, Maine. She's interested in technology, literature, and how the world will change in the future. You can reach Amy on LinkedIn, Twitter, or Facebook.