When the negotiating starts, the first question the car salesman might ask is, "How much of a down payment do you want to make on this little beauty?"Consider your answer carefully since the decision you make can have far-reaching effects on the economic health of your budget. What makes this a tricky question is that the down payment affects more than just your monthly payment. In fact, the wrong decision could cost you several thousand dollars in cold hard cash. How? Well, leasing and buying are two very different ways of financing. You need to know the rules that apply to each so that you can maximize your money.

Down Payment for Car Buying

Let's look at financing for car buyers. Traditional wisdom was that a buyer should make at least a 20-percent down payment when buying a car. It turns out that traditional wisdom is still sound advice. When a buyer puts down 20 percent at the time of purchase, he or she has effectively paid for the first year's depreciation up front. This means that the buyer is not "upside down" on his or her loan. Being upside down means owing more on the loan than the car is worth.

What's so bad about being "upside down?" Say that a financial setback forces you to liquidate your assets. You would have to pay money to get rid of the car. Similarly, if you wanted to trade in your car for a new model, you would have a negative equity. This would mean your trade-in would not be a down payment. Instead you would have to pay for the price of the new car plus what you owed on the trade-in.

Smart money managers, who make a 20-percent down payment, have more freedom to make a change in the car they drive. During the second year, when the car depreciates at a much slower rate, they would begin to build equity in their car. During a trade-in, they would actually get a positive credit toward the new car.

Down Payment for Leasing

The strategy for leasing a car is the opposite of buying — no down payment is recommended (in leasing, the down payment is called a "cap cost reduction"). Often, consumers put down as much as $3,000 to lower their monthly payment. While it's true that the monthly payment is reduced, consider this: If the buyer gets into a serious accident in the first few months of his or her lease contract, and the car is totaled, the down payment is completely lost. Even with collision and gap insurance, no portion of the $3,000 down payment is ever refunded.

So, when leasing a car, take the $3,000 you wanted to put down on the car and open a separate bank account. Make higher payments out of this account rather than putting the money down on the car. You can go one step further and roll the "drive-off costs," which would normally be paid upfront, into your monthly lease payment. Drive-off fees are the related fees required to drive your car off the lot: security deposit, acquisition fee, etc. You drive off the lot with no money tied up in your car and all of it in your pocket (or bank account). After all, the appeal of leasing is to maximize your cash flow. How can you do that with your money tied up in a large down payment?

Summary

Remember that when you are arranging the financing of your next car, you need to look at the initial cost, as well as the long-range financial picture. Ideally, you want to maximize the power of your money while retaining as many options as possible. A 20-percent down payment for buyers and a zero down payment for leasers will put you in the strongest possible position.