What is the purpose of the first payment in car loans?

Question

I'm in the process of buying a used car again. This involves taking a loan from the bank because I don't have enough cash on hand. The precise term for the kind of loan I'm taking might be "leasing", but I'm not sure - English is not my first language. In essence, the car is actually sold to the bank and they own it until I've paid off the loan. They allow me to officially use it, subject to a bunch of restrictions.

The whole thing is pretty straightforward, except for one thing which baffles me - the bank requires me to make a large "first payment" for the whole thing.

So, for example, if the car costs 1000€, then the bank requires me to pay them 150€ (15%) as a "first payment" (plus some fees). They then supply the remaining 850€ and pay the car salesman with that.

But, no, wait, it gets even better than that. They don't actually want the 150€ from me. After I've signed all the papers and paid the fees, they simply transfer 850€ to my account and I add the missing 150€ myself and then I get to pay the salesman myself, however we agree (cash, bank transfer, whatever).

Now this thoroughly confuses me. Why all the shenanigans with the "first payment"? What's the difference to them if I take a loan for 1000€ without a first payment, or 1176.47€ with a 15% first payment? In either case they transfer 1000€ my account. This seems completely pointless to me.

Even more - if I did not have the wad of cash, I could just take another loan for 176.47€, then take the bigger loan, and then use it to pay off both the first loan and the car. I know the bank wouldn't be happy about that (because I circumvented their "first payment" scheme), and I have an inkling they might even be able to get me in legal trouble about that, but how? What laws or agreements would I have broken? And why is it so important to them in the first place?

Note about jurisdiction: this is in the EU, Latvia. However I expect that the general principles will be the same worldwide.

Answer 1

In many places it's called a down payment. The point is to reduce the lender's risk. If all they've lent you is 850€ and the car is worth 1000€ they are less likely to lose money in a situation where you stop paying. If you stopped paying, they'd repossess the vehicle and deal with selling it back to a dealership which would take some time/money. Additionally, in many places they can't simply repossess the vehicle immediately after a missed payment, so the car continues to decline in value while they aren't collecting payments. The down payment helps offset those costs/losses. Similarly, by requiring you to have significant equity in the car up front you have more to lose if you don't keep up on payments.

Typically, you can't just get a higher loan to cover the down payment, the lenders will know the sale price from the car dealer and will lend you a percentage of that price. If your income is sufficient and you are deemed creditworthy you can get loans with no or low down payments, but often times this results in a higher interest rate.

Also, a lease is more like a long-term rental, what you've described is a standard auto loan.

Answer 2

Normally, you cannot simply take a higher loan, because you have no security for it (at least not in the car you buy; of course, you can put your house up or other things).

The reason for the large 'down payment' is that cars immediately lose significant value when they go from 'new' to 'used', instantaneous. Once the car is registered to you and you drive it off the lot, it is typically worth 10-20% less than it was before (why? Well, how much less would you pay for a used car, compared to a new one?).

Therefore, the loan is only for the used-car value, and the immediate loss is what you pay with the down payment.