Financial steps to take before buying the car

Buying your own car means freedom and literation. The downside is there are many financial costs that come with owning a car. Make sure to take these steps before you purchase the car.

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Toyota Motor Corp's self-driving technology "Mobility Teammate Concept" prototype car is displayed during the Toyota Advanced Technologies media preview in Tokyo, Japan, October 8, 2015.

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.

That preparation can pay off in valuable ways: You’ll have more confidence and feel more in charge. You’re likely to get a better price on the vehicle of your choice and more favorable loan terms. And you’ll likely have a lower-stress, more successful experience.

To help make your car-buying journey as efficient and successful as possible, our guide will tell you how to:

  • Check your credit report and score
  • Get preapproved for a loan
  • Get the most out of trading in or selling your current car
  • Set a realistic budget

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.

“We encourage consumers to responsibly manage their credit before they need a loan. For example, make all payments on time, regardless of whether they are loan payments,” advises Natalie Brown, vice president of consumer lending communications at Wells Fargo.

If you haven’t done so recently, you’ll want to get a copy of your credit report fromAnnualCreditReport.com, which provides a freebie once a year. Make sure all the information is accurate and up-to-date. If you see errors, you can dispute them and perhaps get them removed.  And check your credit score, too. Many credit card companies include the cardholder’s credit score on the monthly statement. If yours doesn’t, you can request your credit score for a small fee from the three major credit reporting agencies: Equifax, Experian and TransUnion.

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. If you’re young, with little or no credit, and you can’t qualify for a loan on your own, you should talk to your parents or another older relative about co-signing for your loan. Also, “if you have a short credit history, it will improve your chances for getting approved if you come up with a larger down payment,” says Ron Montoya, senior consumer advice editor at the auto website Edmunds.com.

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.

You can check loan rates at banks, credit unions and other lenders. Start with the bank where you keep your checking account; some banks have discounted rates for established customers. Credit unions often offer their members significantly lower interest rates for new or used car loans, so if you don’t belong to one, you might consider finding one to join.

Once you’ve compared terms from several lenders, fill out a credit application and ask to be preapproved. Bring the preapproval letter, with the loan amount and the interest rate, with you to the dealer. It can be a powerful bargaining tool. If you let dealers know you’re preapproved for a loan they’ll often try to improve on the terms because they can make a substantial profit if they provide you with a loan themselves or through one of their partners, says a J.D. Power spokesman.

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 such as CarMax, 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.

Another alternative, which can involve less stress and a better price, is to go through a large national used car chain with more standard, transparent procedures. “I recommend taking it to a CarMax location near you. They’ll give you a price quote that’s good for seven days. That sets a baseline price, and often the dealer will not be able to beat that,” says Ron Montoya, senior consumer advice editor for Edmunds.com.

Trading in your car at the dealer is easy, but it also gives the dealer a way to try to maximize its profit from your deal, say J.D. Power analysts. However, if you don’t want the hassle of managing the sale or if your car needs a lot of work to get it ready for another owner, you might be better off accepting the dealer’s trade-in offer.

Before taking your car to the dealer, look up the Kelley Blue Book trade-in value. Once you’re at the dealership, one way to counter dealer gamesmanship is to use your smartphone or tablet to check prices while you’re negotiating. “If they value your trade-in at $5,000, you can go to KBB.com and see what others are paying. It’s your right to make sure you’re getting a good deal. Just say, ‘Hold on, let me check that.’ It may be if you pop 30 minutes down the road, they’re paying $8,000,” says Akshay Anand, an auto loan analyst at Kelley Blue Book.

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.

It’s also helpful to compare this budget against an online car affordability calculator, like the ones found at car sites like Edmunds.com and NADAguides.com. These calculators start with what you think would be a comfortable monthly payment, then estimate how much you can afford to spend on a vehicle. “Many consumers think of their car budget in terms of what they can afford per month, say, $300 a month, but they don’t know what type of car they can afford,” says Montoya.

Plug in your desired monthly payment, loan length and estimated interest rate. Also enter any cash down payment or trade-in amount. The calculator figures in taxes and fees, and presents you with an estimated sticker price range that you can afford. It will also list some models in that price range so you can start browsing.

Conclusion

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.

Jeanne Lee is a staff writer at NerdWallet, a personal finance website. Email: jlee@nerdwallet.com.

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