Whatever the reason you may be looking for car finance, having enough cash in the bank for a deposit might not be the first thing on your mind.
A deposit is an initial upfront payment that, in the case of a car loan, represents a percentage of the total value of the car.
While it’s not always essential to have a deposit for a car loan, some lenders may insist on it as a way of reducing risk.
Whether a deposit is required, and how big the deposit should be, will generally come down the lender’s maximum loan-to-value ratio (LVR), which is the percentage of the car’s value that the lender will allow you to borrow.
For example, if a lender’s maximum LVR is 80 per cent, you will be required to pay a deposit of at least 20 per cent of the car’s value. But if a lender’s maximum LVR is 100 per cent, you may not be required to pay a deposit at all.
Keep in mind, however, that even if you aren’t necessarily required to pay a deposit on your car loan, there can be a number of advantages to doing so.
In what ways could I benefit from having a car loan deposit?
If you are able to dip into your savings for a deposit, you may find that it could be beneficial for more reasons than one, including the following.
1. Increase your chance of approval
If you have bad credit, or no credit history, you might find that a deposit could help with the approval process. Lenders typically consider loans with a lower LVR to be less of a risk than loans with a higher LVR. If you’re not able to use your credit score to prove that you are a reliable borrower, a deposit could potentially help to get your application over the line.
2. Secure a lower interest rate
Having a deposit could open up more competitive interest rates as lenders often reward borrowers for lessening their risk. Some lenders may also be willing to negotiate the interest rate in order to gain your business.
3. Reduce your repayments
Paying a deposit on your car loan can also help to reduce your repayments and overall interest costs, as you will have less owing on your loan. Alternatively, if your budget allows for the repayment costs calculated without a deposit, you could leverage your deposit by shortening your loan term.
Take Karina, for example. Karina wants to take out a loan to buy a $30,000 car. She has enough money in her savings account to make a deposit of $5,000 but wants to weigh up her options first.
She begins by comparing loans and selects one that charges an interest rate of 6%.
Option 1: If she decides to keep her savings and refrain from paying a deposit, her estimated monthly repayments on a five-year term would be $580, and the total interest payable over the life of the loan would be $4,799.
Option 2: If she decides to use her savings to make a $5,000 deposit, her estimated monthly repayments on a five-year term would be $483, and the total interest payable over the life of the loan would be $3,999.
Option 3: If she decides to make a $5,000 deposit and shorten her loan term to four years, her estimated monthly repayments would be $587, and the total interest payable over the life of the loan would be $3,182.
Karina wants to prioritise saving money on interest charges, so she settles on the third option. She likes the fact that she would be able to save over $1,600 in interest charges compared to the no-deposit option, while only having to pay $7 extra per month. Plus, there’s the added bonus that she’ll pay off her loan a full year earlier.
|Option 1||Option 2||Option 3|
|Loan interest rate||6%||6%||6%|
|Loan term||5 years||5 years||4 years|
|Total interest payable||$4,799||$3,999||$3,182|
Source: RateCity.com.au. Notes: Based on excellent credit rating.
What else should I consider before using my savings for a car loan deposit?
If you’re in a position to be able to dip into your savings, or you have the luxury to take some time to save up, then it might be worth considering putting a deposit on your car loan.
However, if you can’t spare the cash and your need for a car is pressing, you may still be able to get a car loan that works for you.
It’s also important to remember not to use all of your spare change on a deposit, as car ownership comes with a number of other ongoing expenses such as registration, insurance and maintenance costs.
Deciding whether or not to pay a deposit on your car loan will ultimately depend on your personal financial situation. Doing your calculations and weighing up your options can help you make a well-informed decision.
For information and advice specific to your unique circumstances, consider reaching out to a financial advisor.