5 financial steps to take before you buy a car

The 2012 car models will soon roll out to dealerships. If you’re looking to buy a car, you've undoubtedly done your research in advance about the right model and trim. The key to affording your dream ride works the same way: Get your financial situation under control before you step foot on the car lot. Here are five crucial steps to take that will help you save thousands of dollars when you buy a car:

1.Know your credit score

A 2012 Ford Focus Hatchback and other sedans are lined up at the Salem Ford dealership in Salem, N.H., this month. Before you buy a car, check your credit score to make sure you qualify for the best loan terms. (Charles Krupa/AP)

If you plan on using financing to buy a car, your credit score is key to getting the lowest interest rates. Your credit score is a three-digit number that uses your credit information to assess how risky a borrower you are, and it can significantly influence how lenders decide the terms of your loan. The higher your credit score, the lower your risk and the lower your interest rate. The lower your credit score, the riskier you are and the higher your interest rates. Be proactive in checking your credit score beforehand so you know where your credit stands before you apply for a loan.

You can check your credit score for free at my company's website, CreditKarma.com, or other credit score websites. Aim for a 720 credit score or higher, which is considered the threshold for the best interest rates. If your credit score still needs work, consider holding off on your new car purchase and taking the next few months to build better credit to score better interest rates, which can save you hundreds of dollars in interest over the life of your loan.

Calculate how much car you can afford

Michael Elmassih (right) concludes a sale with Eric Montalvo, who is buying his first car at Quincy International Auto Sales in Quincy, Mass., in this 2008 photo. Mr. Montalvo put down 30 percent of the price and the bank quickly approved the loan. (Melanie Stetson Freeman/The Christian Science Monitor/File)

Consumers carried an average of $15,275 in auto loans in August. Depending on the type of car and your financial situation, be mindful of how much you need to borrow in order to finance your car. If you can’t put down a significant down payment, taking out a large loan and having high monthly payments may mean the car is out of reach for your budget. A general rule to follow is that your monthly car costs, including loan payment, auto insurance, and fuel costs, shouldn’t exceed 20 percent of your disposable income – your money left over after paying bills, living expenses, and debts. Take advantage of free resources like Edmunds.com’s affordability calculator to narrow down the price range of cars that fit your budget.

Research the value of your car

Cary Caldwell, an auto appraiser for CarMax, inspects a vehicle brought in for trade in Irving, Texas, in this 1998 photo. CarMax relies on getting cars from individual owners more than the traditional large auction houses. Before trading in your car, find out its value. (Andy Scott/Dallas Morning News/Newscom/File)

Before walking into a dealership, the best negotiating tactic is to know the value of the car you want. Do your homework and research the true price of the car, which will help set a realistic target price. That allows you to assess if you can afford the car, and puts you in a better position to negotiate. TrueCar is a helpful tool that provides the expected price of the car, based on aggregated data of how much that specific car sells for in your zip code. This price gives you and the dealer a fair starting point for negotiation.

Consider different financing options

RoadLoans.com launches its next-generation website, which features a host of online tools for car buyers, as well as online loan and refinance applications. Check out all your financing options before you decide on one. (RoadLoans.com/PRNewsFoto/File)

While paying in cash for a car can help you negotiate a lower price, it's an option that is out of reach for many consumers. There are various loan financing options available, so be sure to research your options for the best deal. While dealer-sponsored financing may be convenient, you may be able to find better terms, lower rates, and more open financing policies at a credit union or local bank. Be sure to research and compare across different auto loans, including the loan term, the annual percentage rate (APR), as well as any additional fees or penalties. Also, getting a pre-approved loan from your credit union or bank could give you added confidence in negotiating a good price.

As a general rule, keep your loan term to five years or less; the longer the loan term, the higher your interest costs will add up by the end of the loan term. Just make sure you don’t wait until the last minute to figure out your financing options; you may end up relying on a dealer's loan and held to his loan terms.

Check for savings opportunities

Car dealerships are seen along Northern Boulevard in New York last year. Be sure to check for any factory or dealer incentives for the model car you want to buy. (Shannon Stapleton/Reuters/File)

Before you hit the car lot, check for any factory or dealer incentives offered on the car you want. Search online for the make of your car and type in “factory and dealer incentives.” Doing a little homework is an easy way to walk in with another bargaining chip to lower the car’s sticker price. Or, if you’re planning to trade in a car, find the trade value of your old car in Kelley Blue Book.

While the car’s maintenance history and condition will affect the trade-in value, dealers are notorious for low-balling consumers when purchasing their trade-in. Make sure you don’t get taken advantage of and set reasonable expectations based off of your car’s Kelley Blue Book resale value. Don’t be afraid to ask questions or ask if they can offer more; it doesn’t hurt to be straightforward and honest when you negotiate.

Justine Rivero is the credit advisor for Credit Karma, a credit management and education company for consumers and based in San Francisco.