Financial Steps to take Before Buying a Car

cars with SALE letters on them

A car is often the second-largest purchase consumers will make, after a house. 

Like buying a home, purchasing a car often involves taking out a substantial loan and making years of monthly payments. Such high stakes can seem overwhelming, but don’t despair. You can take a few steps now to ensure you’re financially prepared for the car-buying process.

Step 1: Check your credit report and score
The better your credit history and score, the lower your costs should be when you borrow money. Banks, credit unions and other lenders reference your credit history and score when setting the interest rate and other terms on your auto loan. If you’ve paid your bills on time and established a track record of using credit responsibly, you’ll be rewarded with a more affordable auto loan.  If your credit is less than excellent, you won’t qualify for the best deals, but you will probably still be able to get a loan if you’re willing to pay a higher interest rate. 
Step 2: Get preapproved for a loan
Shop around and get preapproved for an auto loan that has the best terms you can qualify for before you go to the car dealership. While dealerships will gladly arrange financing, they will also frequently charge a markup, sometimes called a dealer reserve, for matching you up with one of their bank or finance company partners. Whether that’s 1% or 2% or more added to the base interest rate charged by the lender, the exact markup is at the dealer’s discretion and is typically not disclosed to the customer.
Step 3: Determine what to do with your existing vehicle
Do you have a vehicle to trade in or sell? It helps to have a good estimate of what it’s worth. You can sell your old car to another consumer, or to a national used car chain, or trade it in at the dealer. This is basically a trade-off between convenience and price.
You’ll likely get more money by selling it yourself, but that involves the risks and challenges of dealing with strangers. It’s also a lot of work: You’ll need to clean and prepare the car, evaluate its condition, look up the Kelley Blue Book value for selling to a consumer, advertise, negotiate the price with potential buyers, and do the paperwork to transfer the title. The DIY route may be worthwhile if your car has been maintained so well that you feel it will fetch a premium, and if you’re willing to put in the time and effort in order to maximize the cash value.
Step 4: Set your budget
Now that you’ve done all this legwork, you have the information you need to set a realistic budget. To figure out how much you can spend, add together your preapproved loan amount, your trade-in value or what you got through selling it yourself, and any cash you plan to use for a down payment. You should shop for models a few thousand dollars below that total, to leave room for taxes and fees.

Going through these steps will give you firm benchmarks for your cost of financing and a good idea of the types of vehicles you can comfortably afford. And having a clear picture of your finances will help power you through your auto negotiations with confidence.