Why save before financing?
‘Financing’ a car refers to the practice of taking out a car loan and then gradually repaying it. While some dealers may offer financing with no down payment, there are a number of benefits to saving up as much of a down payment as you can before financing:
- Reduce monthly expenses. A high monthly car payment can be a serious financial strain if you encounter an emergency where your income is hampered (for example, a global pandemic). Making a larger down payment up front will reduce your monthly loan payments, and put you in a better position to weather unexpected financial storms.
- Reduce interest payments. The bigger your down payment, the smaller your car loan. The smaller your car loan, the less interest you’ll ultimately pay over the course of your loan term.
- Tackle other goals. Devoting less of your monthly income to a car loan frees you up to reach other financial milestones, like paying off debt, investing, or saving for a down payment on a home.
How to put together a down payment
Work out how much car you can afford
Sit down with your budget (or if you don’t already have one, create a budget) and determine how much room you’ll have for monthly car expenses. Aside from the car payment itself, don’t forget to include additional costs like gas, insurance, registration, parking and maintenance. You should avoid spending more than 10-20% of your net income on transportation costs, so that you’ll have enough money left over for housing, food, and savings.
Set a car price and down payment goal
Next, you’ll need to decide whether to purchase new or used, which usually depends on your monthly budget. If your ideal car is well within your budget – great! If not, you’ll need to either buy a used vehicle or save a substantial down payment.
A used car has the benefit of being more affordable, but buying a used car also comes with some risk, because there is more wear and tear on the vehicle. You can use websites like Kijiji and AutoTrader to find out the average asking price of used cars.
If you plan to save a down payment, use a loan calculator to see the impact of various down payment sizes. Keep in mind that there is no limit on the size of your down payment, but 10-20% is a good starting point.
Use the car loan calculator
Cutting expenses is a tried and true way to allocate more cash to your monthly savings, which will help you amass a down payment faster. Here are some quick and easy ways to cut your costs:
- Buy generic rather than brand-name groceries
- Switch to cheaper providers for fixed expenses like insurance, telephone, and internet
- Cut cable and unnecessary streaming services
- Take public transit, walk, or bike to your destinations
- Make purchases using a cashback credit card
- Save extra on your purchases with cashback apps
Earn more money
Increasing your income may be a more viable option than you might think. Review each of the below strategies and carefully consider if any are a realistic option for you:
- Work overtime
- Ask for a raise
- Start a side hustle
- Sell personal items that you may no longer need
- Save all windfall cash such as income tax refunds
Amplify your savings
The best place to park the cash you accumulate for a vehicle down payment is in a high-interest savings account. These savings accounts let you earn a high interest rate (for example, EQ Bank’s Savings Plus Account is currently offering 2.50%* interest on new deposits) but keep your money easily accessible/liquid.
Some banks let you set savings goals and track your progress, or you can do this yourself in an excel spreadsheet or money management software. I recommend setting up automatic deposits to move money into your savings account after every pay period, which eliminates the temptation to spend. To supercharge your savings, use other automation tools, like KOHO, which rounds up your purchases to the nearest $1, $5, or $10, depositing the excess into a savings account.
- Interest is calculated daily on the total closing balance and paid monthly. Rates are per annum and subject to change without notice.
Hunt for favourable financing
If it will take you a prohibitively long amount of time to save up the cash for purchasing a vehicle outright, try to at least shop around for the best loan terms possible based on your income and savings. I recommend consulting with an online loan aggregator like Car Loans Canada, which matches you to different vehicles and financing options based on your financial profile, and can save you an enormous amount of time spent physically trekking from one dealership to the next to compare rates in person. Another option is CarLoans411, which specializes in matching Canadians to a car loan no matter their credit score.
If you’re buying a used vehicle via private sale, consider turning to your bank for a loan, particularly if you’ve been their client for a long time, as you might be able to leverage your relationship for a lower interest rate.
Patience is a financial virtue
Some of us are understandably hesitant to make the short-term financial sacrifices necessary to save up a healthy down payment. But while you may be tempted to jump on the $0 down payment offers available at many dealerships, the reality is that saving up for a car before financing always makes long-term fiscal sense. In my case, I used the strategies outlined above to put down 20% for both of my used vehicle purchases. This 20% reduced my monthly payment to a manageable level, which helped me focus on achieving my other financial goals.
How much do I have to save for a down payment on a new car?
Most dealerships will offer to finance your vehicle with no down payment. That said, it’s a good idea to save a 10-20% down payment because your new car will lose value as soon as you drive it off the lot. A sizeable down payment protects you if something happens to your vehicle and you end up “underwater” on your loan, i.e. what you owe on the loan exceeds the car’s value.
Does my credit score affect how much I have to save?
Your credit score does indirectly affect the size of your down payment because it affects the types of lenders that will work with you. Dealerships and primary lenders (like banks) require credit scores in the “good” range to qualify for a loan. If you have a low credit score, alternative lenders will work with you, but they may require a larger down payment to approve your loan.
What do I do if I need a car now, and can’t save a down payment?
If you need a vehicle immediately, use whatever free cash you have as a down payment. Choose a lender that allows you to make extra payments on your loan or pay it off early with no penalties, and then use the steps outlined above to pay off your loan as quickly as possible.