How does down payment impact car loans

There are multiple banks and NBFCs in India that offer car loans to aid customers to buy their dream car. The best part is that you have the option to make a down payment for your car while purchasing it. Such a facility helps the customers to borrow a smaller loan and pay the debt in a shorter time.

Let us give you a better understanding of this concept and the benefits associated with it so that you can make an informed decision.

What is a down payment?

Down payment in car loan is the upfront payment that the borrowers put toward the purchase price of the car. Making a down payment reduces the overall size of your loan. The payment can be done in the form of a cash, cheque, demand draft, electronic payments etc. depending on the retailer.

Effect of down payment on a car loan

Down payments are inversely proportional to car loans. It means the larger down payment you will make initially, the less you will need to borrow from the financial institution. This will, in turn, enable you to repay your loan faster as you need to pay a small amount of EMIs. Hence, making a down payment on a car makes a loan affordable for you.

For example- If you are planning to purchase a car worth Rs. 3 lakhs with a tenure of 5 years. And if you make a down payment of Rs. 80, 000 then, you will have to take a loan amount of just Rs. 2.2 lakhs which should be paid back within 5 years along with the interest. However, if you decide to pay Rs. 1.5 lakhs upfront, in that case, you will have to repay a loan amount of Rs. 1.5 lakhs excluding the interest. When this loan will be repaid in 5 years, it will significantly reduce the sum that you need to pay as equated monthly instalments (EMIs).

Effect of down payment on loan tenure

The loan tenure plays an important role in car loans, as this impacts the EMI you will have to pay every month. When you opt for a longer repayment tenure, you need to pay less EMIs every month along with the increased rate of interest. If you are choosing to pay a large sum as a down payment and borrow a small amount through a car loan, your repayment capacity will increase and you will be able to repay your loan fast, while saving your money on interest.

On the other hand if you agree to pay a large sum upfront and are still willing to pay the same EMI for the same loan tenure, in that case, you will have more funds available, when you do not make a payment. This way, you will be able to purchase a car of a higher price. 

This can be further explained using the following examples:

Example 1 – Suppose an individual wants to buy a car priced at Rs. 3 lakhs without making any down payment, in that case, he/she will be able to repay the debt in 5 years considering his/her maximum repayment capability. However, if he/she decides to pay Rs. 1 lakh with upfront cash, the loan tenure will reduce to 3 years if the person is willing to pay the same amount as EMI.

Example 2 - Like the previous example if a person plans to purchase a car of Rs. 3 lakhs without any down payment considering the maximum repayment capability of the candidate is Rs. 5,000 for the maximum loan tenure. In such case, the candidate can purchase a car worth a maximum of Rs. 3 lakhs. However, if the individual decides to pay Rs. 1 lakh as an upfront amount and is still willing to pay Rs. 5,000 as EMI for the same loan tenure, he or she will still receive Rs. 3 lakhs as loan. But, in this scenario, the person can buy a car worth a maximum of Rs. 4 lakhs.

How down payments affect the interest rate?

Paying a substantial amount as a down payment will help you to reduce the loan amount that you need to avail of. This will further lower the interest rates and the payable EMIs. A large down payment will increase your chances of securing a loan and allow you to repay it in a shorter time.