Do I Need A Deposit For A Car Loan?
Car loan deposits can bring you many advantages.
Having a deposit for a car loan isn’t mandatory, but it can help with your approval process and reduce your repayments. Some lenders will insist on a deposit when applying for a car loan, while others may offer a loan for the entire value of the car. Having a modest (10-20%) deposit for a car reduces risk on the part of lenders. In some cases, a borrower may be rewarded with a more competitive car loan interest rate.
Statistics on car loan deposits
According to ASIC MoneySmart, the average purchased car cost is $27,994; the average loan amount is $18,409. This doesn’t necessarily mean the average deposit is around $10,000 – however it does give us an insight into how much people save up for before looking for a loan. In fact, 59% of Australians opt for a car loan when purchasing a vehicle.
Loan to Value Ratio – What does it mean?
Researching car loans and car loan deposits, you may have come across the term “LVR” or “Loan to Value Ratio.” The LVR is a calculation that helps show you the overall risk involved when applying for a car loan. LVR is expressed as a percentage: 50% LVR means a loan that covers 50% of the purchase price of the car, with the other 50% purchased with some sort of deposit. The LVR is the proportion of how much the loan is covering the cost of a car (or asset) and how much the borrower is purchasing outright with their own money. The part the borrower owns outright is known as equity.
Having an LVR of 80% means the borrower is putting down 20% deposit, and so on. In some cases borrowers may be eligible for 100+% LVR, which means they can pay off extras such as insurance and registration with the loan. 100% or over LVR loans are much higher risks for lenders and they may want to charge higher interest rates to cover potential losses. 100+% LVR loans are more common in commercial car lending (chattel mortgages and hire purchases).
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Why a deposit can improve your car loan interest rate
Having a deposit when buying your car means you have “skin in the game.” That means you are taking on more of the risk instead of the lender. Lenders are risk-averse, which means they reward borrowers who are taking on more of the risk instead. For example, a lender may approve a loan without a deposit for $25,000 at 11%p.a. Over five years, your repayments would be $554 per month with $8,214 paid in interest and fees (assuming a $10 monthly fee.)
If you purchase the same car with a $5,000 deposit, a lender may see this as a lower risk and give you a lower interest rate in return. This means a $20,000 car loan (where you have 20% equity in the car up front) means you’ll pay only $6,393 in interest – which means you’re $293 better off compared with having the same interest rate as the previous loan. This also leaves you with more breathing room per month, as you’ll only have to pay $445 in repayments.
Deposits and bad credit customers
In rare cases, lenders may insist customers with bad credit have a deposit before they approve a loan. Again, this is to lower their risk when lending to a customer with bad credit. The upside is that your repayments may be lower than if you went into the loan without a deposit and you may pay less in interest overall.
Other uses of deposits
If you have saved a substantial deposit for your car, you may want to reserve some of the saved money for on-road costs, so you aren’t further out of pocket. If we take the above example, spending $1,000 of your $5,000 saved on comprehensive car insurance for a year – which is mandatory when taking out a car loan – means you will be paying an extra $22 a month. However, This can save you on premium loading, which is the added fee/penalty insurance companies place on premiums paid by the month.
The pros and cons of having a car loan deposit
More competitive interest rates
Having a large deposit saved to put toward a car can, in some instances, allow you to access more competitive interest rates, as the lender is taking on less risk.
Better chance of approval
Because the lender is risking less, those customers with bad credit may find their chance of car loan approval improves.
Lower interest paid overall
It’s simple maths – the lower your loan amount, the less you pay in interest.
Waiting may mean less purchasing power
If it takes you years to save up for a large deposit, you may find the car you want further and further out of your price range. That’s because inflation can eat into your savings by the time you have enough to purchase.
Good for “wants” vs “needs”
Saving for a deposit is good for a car that you “want” and isn’t totally necessary. If you need a car to get to work or for family life, saving may not be the best option.