How Much Should a Car Down Payment Be?

Conventional wisdom has long held that 20 percent is the magic down payment number when you're buying a new car. But the vast majority of people are making far smaller down payments. An Edmunds analysis of new- and used-car purchases in 2015 showed that the average car down payment was about 10.4 percent. In fact, people haven't been following the "conventional wisdom" for years.

That raises a few questions: Why are people paying so little? Is the 20-percent-down rule outdated? Are there any drawbacks to a smaller down payment? If 20 percent isn't the magic number, what is?

The following advice applies to financing the purchase of a new or used car. If you are leasing, the advice is much simpler: Put as little down as possible. Ideally, you'd pay only the drive-off fees.

Why Such Small Down Payments?

The explanation for the prevalence of small down payments is simple: It's all people can afford.

"The main reason why people aren't putting enough down is because the cost of the vehicle has substantially increased, but people's income has remained relatively flat," says Jack Gillis, director of public affairs for the Consumer Federation of America.

The average down payment actually has gone up slightly since 2005, when it was at 9.9 percent. Meanwhile, the cost of a new car has gone up more than 10 percent in that time, according to Edmunds.com.

The Down Payment Sweet Spot

The ideal down payment doesn't have to be tied to a specific percentage. It should be an amount for which you can reasonably save without putting a hole in your savings. Keep in mind that your trade-in can also serve as your down payment, provided it has enough value.

The wisdom of the crowd currently says a down payment should be around 10 percent. And that can work, provided you take some precautions against depreciation. Here's what we mean: If your new car is totaled or stolen in the first couple years, which is when it typically loses about 20-35 percent of its value, a 10 percent down payment won't provide enough equity to cover the balance of the loan. This is why you need GAP (guaranteed auto protection) or new-car replacement insurance.

GAP insurance costs a few hundred dollars but can offset any difference between what you owe and what the insurance company gives you if your car is totaled. Dealerships, auto insurance companies and third-party brokers all offer GAP insurance. One thing to note about GAP insurance is that it does not cover you if you're simply tired of the vehicle and want to trade it in or sell it.

New-car reimbursement coverage is readily available from a number of insurance companies, including Farmers, Liberty Mutual, Travelers, Allstate and Amica. If your car is totaled or stolen within the first or second year of ownership, the insurance company will pay the full cost of having it replaced. All you have to do is pay your deductible.

Prices vary. For example, Farmers Insurance said its customers pay an additional 4-6 percent of their comprehensive and collision premium for new-car replacement coverage. The company also offers GAP insurance on a state-by-state basis, for approximately 7 percent of the customer's comprehensive and collision premium. These prices may vary based on the driver and other factors, a Farmers spokesperson said.

Combining a 10 percent down payment with the GAP insurance or new-car replacement coverage lets you keep more money in your pocket without the risk of being underwater on your car loan.

The 10-percent-down strategy isn't a universal solution, however. Here are a few other down payment philosophies.

Zero Down

Paying nothing down keeps the most money in your pocket. You can get into a new car without having to save for months in advance. Your credit, however, needs to be in great shape, in order for the finance company to approve the zero down. Two drawbacks are higher monthly payments and higher finance charges. (Finance charges aren't an issue if you qualify for zero percent APR.) And, as in the 10-percent-down scenario, you will be upside-down on the car loan, initially owing more money than the car is worth.

What about those widely advertised "Zero Down/Zero APR" specials? They draw shopper attention, but as few as 10 percent of shoppers will qualify for them, Gillis says. And even if you are one of them, Gillis still recommends you make a down payment. This reduces the amount of debt you are taking on.

If you want to go the zero-down route, we highly recommend GAP or new-car replacement insurance.

Somewhere in Between

Clearly, 20 percent down is more than most people can save up. And zero percent down may not be available to everyone. So most car buyers wind up somewhere in between, putting some money down, but not enough to jeopardize their savings.

Take a look at your budget and see what percentage of the car's purchase price works best for you as a down payment. Use the Edmunds calculators to enter different down payment amounts and see how they affect the monthly payment. The general rule is that for every $1,000 that you put down, your monthly payment will drop by about $20. If depreciation would put you at financial risk in the event of an accident, pencil out the cost of GAP insurance or new-car replacement coverage.

Go With the Most You Can Afford

Though saving up 20 percent may be difficult, a large down payment does give you many benefits. If your budget can accommodate it, a bigger down payment will allow you to choose a shorter finance term, which will save you money in interest charges. It will also cover most of the first-year depreciation and give you enough equity so you don't have to come up with additional money if you decide to buy a different car before you pay off the loan. And if you have a theft or car-totaling accident, you probably won't owe anything on the vehicle. Plus, you can safely skip on the GAP insurance and new car-replacement coverage.

Down Payments for Buyers With Subprime Credit

Having so-so credit doesn't mean you can't buy a car. But if you have a FICO score of about 620 or below, making a bigger down payment could increase the chances of your getting approved for a loan. Banks and finance companies want to lower their risk of not being paid, so they prefer loans with smaller amounts. The more you put down, the greater the chances of being approved.

If you're a buyer with credit challenges, you also should resist the allure of longer-term loans, even though they offer more palatable payments. Lots of people are extending their loan terms these days: Edmunds data shows that the average term of a loan has increased to 68 months: nearly six years. Seven-year loans are not uncommon. But you'll pay much more interest in the long run on such loans. Further, you may get tired of that car before you've paid it off, meaning the loan may outlive the car. Rolling over payments to the next car is a bad start for a new loan.

Used-Car Down Payments

Things are a little different when it comes to used cars. Edmunds data shows that the average used-car down payment also is about 10 percent. That's not a bad thing in the used-car market, where purchase prices are lower and depreciation slower. A five-year-old Kia Soul, purchased in May 2014, depreciated about 10.7 percent by the end of that year. Contrast that with a new car, which saw nearly 22 percent annual depreciation.

Used cars have an advantage in that the original owner "absorbed the initial depreciation," Gillis says. Since used-car shoppers are already offsetting the depreciation with the 10 percent down, our advice is simple: Keep up the good work.