25 June 2020 Concept Car
Are deposits still a thing? Sometimes, they really can seem like fossils from a different era. Car finance has become so much more flexible and customer-oriented. Why, then, should it still be mandatory to pay a big amount of money upfront?
It is easy to see why a lender would want some money in cash. But for you, as a borrower, having to make this payment can make the difference between being able to buy a car or not. No wonder, then, that many are searching for no deposit car finance as a means to finance their vehicle.
But can you trust dealers offering cars without a down payment? And is it even advisable?
In this in-depth article, we’ll take a look at the motivations behind a down payment as well as its benefits and disadvantages. As will become clear, there are many misconceptions on the subject. And it pays to tell fiction from fact.
What we often hear from clients is this: “Financing a car would be easy. If only I did not have to make a deposit!”
First off, there is some confusion about the differences between a deposit and a down payment. At least in theory, the two are not identical. We’ll get into the differences in a little while. For the moment, however, let us assume the two are identical and what people mostly refer to as a deposit is actually a down payment.
Now, to get back on point, how problematic is a deposit really?
Many experts apply the 20/4/10 rule here. It recommends you keep total car costs below 10% of your income, pay off your car within 4 years and pay at least a 20% down payment upfront. (We talked about this in our article on how much of your income should go towards your car.)
In practise, deposits rarely exceed 10%. So, in actual fact, most dealers already ask quite a bit less than what experts recommend. And that’s not all.
Still a decade ago or so, no deposit car finance seemed rather disreputable. If you couldn’t afford to pay money upfront, you had to visit buy here pay here dealers or arrange deals with shady credit providers. Neither seemed a step up.
Today, that picture has completely changed. You won’t have to spend hours on google to find plenty of suitable offers. Dealers have, for the most part, learnt to respect the wishes of prospective customers. And one of the things their customers felt strongest about is the down payment.
Still, down payments haven’t disappeared completely. As you’ll see, there are very good reasons for that. One of them relates to how car finance on the whole has changed.
Essentially, two new forms of car financing are to blame:
Hire Purchase Plans. These look and feel very much like a traditional bank loan. In most cases, they are, in fact, absolutely identical.
Personal contract plans. These look and feel like a leasing scheme with a buy option at the end. PCPs are a new and understandably popular finance option. They allow almost anyone to get a new car, even a great new car. In fact, according to many, they make it far too easy for anyone to get a great new car.
PCPs and HPs both aim at keeping monthly rate payments very low. As a result, to reduce the risk for the lender, both still work with a deposit. In case of Hire Purchase, this deposit can be very low, sometimes it can even be waved. But with a PCP, a minimum of 10% is usually required.
Despite this, PCPs have quickly become the most popular car finance model in the UK, far ahead of the traditional bank loan.
Before we get into the nitty gritty, let’s first make some subtle, yet important distinctions. A little earlier, we mentioned that a deposit and a down payment are not really the same thing at all. So what’s the difference?
In the original meaning, a deposit is a payment you make prior to signing the actual contract. It signals to the dealer that you’re serious about the transaction. Usually, it also means the dealer will reserve the car for you and not offer it to other potential buyers for the time being. Depending on the terms, a deposit can be refundable (it usually is) or non-refundable. In the latter case, if you decide not to buy the car after all, you won’t get your money back. Understandably, these non-refundable deposits are a lot lower. If you do decide to buy, however, the amount is always deducted from the purchase price.
A down payment, on the other hand, is a one-time upfront payment towards the car. It serves to reduce the lender’s risk of you defaulting on the credit. It is applied before working out the car loan. So, effectively, it also either reduces your monthly payments or the loan term, i.e. how long you’ll need to pay of the loan.
Although we hardly hear anyone complain about a PCP, they actually, in a way, make you cough up a down-payment twice in a way.
If you think about it, you’ll pay the regular down payment first. Then, at the end of the loan term, you can buy the car with the balloon payment. So a phase of relatively low monthly instalments is bracketed by two fairly high payments.
Most will not be able to afford the balloon payment, which tends to be a lot higher than the initial deposit. Still, this is no reason for many drivers to avoid PCPs. Quite on the contrary, these deals today make up by far the largest chunk of all new car deals.
This leads us to an important insight: Usually, even financially weak car buyers don’t object to a deposit. The overall terms of the loan are what matters. The down payment does play an important role. But in itself, it’s usually not the most important factor.
As a general rule, think of things this way: The higher the down payment, the more the overall contract will resemble a cash payment (a 100% down payment equals buying the car in cash). Here, the risk for the seller is zero. As a result, the price of the car must come down accordingly. The lower the down payment, the higher the risk for the seller. This will translate into a higher interest rate (and, thus, make the car more expensive).
In practise this means the following:
If the deposit is intended to reserve the car for you, then the idea is simply that the dealer doesn’t loose any money by taking the car off the market for you. As you’ll know from personal experience, you may easily opt for a different car after some reflection and decide against your first impulse. For cases like this, the deposit reduces the loss of a potential sale for the dealer.
If we’re looking at more of a down-payment-type of situation, the idea is to limit the financial risk for the lenders. If you make a large initial payment, then this is money on the bank for them. Should you, at some point, no longer be able to keep up your obligations, the loss for the financial services provider will not be quite as bad.
Deposits and down payments are usually regarded through the lens of the dealer/lender only. It is quite interesting to think about what a deposit can do for you, as the car buyer.
We said that a deposit/down payment reduces the risk for a borrower. Interestingly, in most cases, it also reduces your own risk.
If you pay a deposit, the amount is subtracted from the purchase price. As a result, you’ll have to pay less in terms of the loan. You can therefore bring down the monthly payments a bit. This, in turn increases the likelihood of you paying off the car in full. This is good news. A default may be bad news for the dealer. But it is even worse news for you, after all.
A deposit can also help you get better contractual terms and conditions. What’s more, the dealer/borrower may be more lenient if you miss out on a payment once, since you’ve already made a substantial contribution earlier on.
In psychological terms, a deposit is a statement of intent. It signals to you that buying this car is not just another transaction, but something important. Paying a larger sum upfront can strengthen your resolve to make this work.
Very often, the stumbling stone is not so much whether or not to pay a deposit. The real question is how high the deposit needs to be.
Unfortunately, there is no fixed rule on this. We’ve heard of strange cases, where the dealer will increase the deposit in sync with £1,000 increments in purchasing price. So, a £1,000 car would set you back £100. A £2,000 car would lead to a £200 deposit. And so on.
Generally speaking 10% seem to be common practise for a down payment. If the idea is merely to reserve the car while you’re still deciding, it should be substantially lower. Even more so, if the deposit is non-refundable, of course.
The reason experts recommend paying more than that is that a higher deposit can significantly bring down the loan costs and the loan term. So if your goal is to pay off the car as quickly as possible, then a minimum of 20% does make sense.
Higher deposits are rare these days. The reason is that dealers have understood that it makes no sense whatsoever to burden those with a bad credit rating even more. Vice versa, some Hire Purchase Plans will reduce the down payment to zero, since the lender has a lower risk in these plans anyway.
As we mentioned earlier, no deposit car finance is no longer particularly hard to find. We, too, will sometimes agree to deals without any kind of down payment. It just makes sense sometimes.
The question you should ask yourself is: What is my risk as a buyer? There are, in fact quite a few disadvantages and risks attached to this approach:
If you don’t pay a deposit, your overall costs will rise. In some cases, they will rise significantly. So, for the same car, you could end up paying several thousand Pounds in interest. Is that what you really want?
Not paying a deposit can lead to two things: Either, you pay more each month. Or you stretch out the loan over a longer period of time. If it’s the former, you expose yourself to a higher risk of a default. Especially now, with the Corona crisis in full swing, many will lose their job. The higher your monthly credit payments, the worse off you’ll be. If it’s the latter, your risk becomes less planable: Who knows were you’ll be, financially speaking, in five years from now?
Sometimes, no deposit car finance will be your only option. And if managed well, it need not be a problem. But yes, there are certain risks attached to it.
Then again, you can also have to much of a good thing. It all depends on what kind of finance deal you’ve struck.
Buyacar.co.uk have explained this in clear terms in an insightful article.
If you opted for a Hire Purchase Plan, meanwhile, a high deposit makes complete sense. The more you pay upfront, the less you need to pay each month and/or the faster you can pay off the loan and the lower will be your overall loan costs.
If, however, you’ve signed a PCP deal, things are very different. The higher the down payment at the start, the lower your financial reserves at the end of the contract. If you can not or do not want to accept the balloon payment, you now have less money to put down for your next car. In a worst case scenario, you may no longer be able to afford a new PCP deal at all and must return the car. Even if things turn out a little bit better, you will have to settle for a much smaller, less powerful and less appealing model.
Needless to say, a very high deposit also leaves you more vulnerable to sudden financial shocks.
What it comes down to is this: Make the deposit as high as possible, but keep in mind what you can afford. And always, always, always, factor in a safety reserve.
It is important to point out, however, that this is not always required. Instead, there are many ways you can improve your financial possibilities and make a down payment after all.
Among your best options are the following:
At Concept Car Credit, we have many years of experience in helping customers getting a deal – with or without a deposit. Talk to us now about how we can be of help.
25 June 2020 Concept Car