What are the advantages of making a down payment?

Question

Consider the following cases examining the benefits of making a down payment.

Case 1: You want to buy a car. Suppose you borrow $15,000 for two years at an APR of 6%.

Case 2:You want to buy a car. Suppose you borrow $15,000 for two years at an APR of 6% and make a down payment of $2,000. This means you borrow only $13,000.

 

What are the advantages of making a down payment? (Select all that apply)

_reduction in the total interest paid over the life of the loan

_increase in the total interest paid over the life of the loan
_reduction in monthly payment
_increase in term of the loan
_increase in monthly payment
_reduction in term of the loan

 

Why would a borrower not make a down payment? Note: One other factor to consider is the interest one would have earned on the down payment if it had been invested. Typically, the interest rate earned on investments is lower than that charged for loans.

Answer 1

Hi, in general, making a down payment reduces your overall interest cost. So the answer should be the reduction of interest costs results from making a down payment.

You would reduce the total amount borrowed, and the interest rate cost of 6% would be lower in total than if you had borrowed the full amount.

Other ideas to consider is that:

1. yes, you could invest your money and try to make more than 6% but remember you most likely will have to pay taxes so the after tax cost would mean that you would have to achieve a rate Significantly higher than the APR.

2. The only other idea I can consider here is that if you do not have the down payment to invest you would have to accept the interest cost. In that case, you should look up ideas around prepayment.

Most loans do not have prepayment penalties any longer, but even if you borrow the full amount that doesn’t preclude you for paying an extra thousand dollars per month or some amount to decrease the overall principal overtime. Which is also a way of decreasing the overall interest cost

hope that helps you, regards, Robert