In discussing the predicament of my prospective client “Irene,” I opined that she made a mistake by giving the dealer a large down payment when she first agreed to buy her car. But last week, discussing the high cost of “gap” insurance, I mentioned that one way to avoid owing more than your car is worth is to increase the down payment.
So which is it? Is a large down payment good or bad?
As is so often true in the byzantine world of car finance, it helps to separate out two different functions of a down payment. Or, rather, the functions of a down payment at two different points in a typical transaction.
The first document you sign in a car deal is the Motor Vehicle Purchase Contract (MVPC), which identifies the car and states a price. The dealer wants to sell you that car, but only if you can come up with a way to pay for it. You, for your part, may want to make sure that the dealer doesn’t sell the car to anyone else in the meantime. You want to hold the dealer to his promise to sell you that particular car. That’s especially important in the world of used cars.
What makes a promise into a legally binding contract? In legalese, it’s called “consideration”: basically, you give something in order to make the other person’s promise binding. This is the legal function of a down payment given at the time you agree on a car.
But the dealer isn’t looking at the down payment in that way. The psychological function of the down payment is as a hook to make sure you buy the car on the terms he will offer later. The dealer will request as a down payment an amount that he figures you can’t afford to lose.
He’ll ask for you to pay it right away and write the amount on the contract in the space where it says that you forfeit that amount of money if you decide not to take the car. If you don’t mention an amount, he’ll ask for what he think you can afford to pay… but not afford to walk away from.
But a dollar is enough to be legal consideration. At this point, you want to put down the absolute minimum amount necessary to hold the car, and then only if it is important for you to hold the car. Otherwise, there is no legal requirement for any down payment. It’s all psychology. You want to be able to walk away from the deal and shop elsewhere if any problems arise. The dealer wants to make it very hard for you to do that.
If you can’t pay cash for the car, you will then sign some documents arranging for financing. Either you’ll get a loan from a bank or credit union, or if financing will be arranged by the dealer, you will sign, some hours or days later, a Retail Installment Sales Agreement (RISA). Either way, at that point it’s in your interest to put down as large a down payment as you can, to minimize the portion to be financed and reduce or eliminate the “gap” between what you owe and what your car is worth.