For many Americans, owning a car is a luxury. For others, it is an absolute necessity. And for some, it may be a mixture of both. But no matter why you decide to buy a car, most people would still like to get the best deal possible.
Unfortunately, getting an affordable deal on a new car — or even a used one — has become more difficult in recent years. In 2018, the average price for a new vehicle hit a record high at $35,631, which is up $4,000 from five years ago. In turn, the average auto loan balance also reached an all time high last year at $20K for used cars, and $32K for new cars.
But while the average price for cars has increased, it doesn’t seem to have dampered Americans’ appetite for car ownership. In fact, a recent Pew Research Center report showed that 88% of Americans owned a car.
Whether you’re a first-time car buyer excited to purchase the car of your dreams or a car-buying veteran who just wants to replace a worn-out vehicle, there are certain guidelines you can follow to make sure you get the best deal possible. With this ultimate guide to buying a car, we’ll walk you through the process so that, at the end, you can be confident you made the right decision for you.
Step 1: Improve Your Credit
Very few individuals have enough disposable cash to buy a car outright. With the average cost of cars rising, it’s no surprise that 44% of American adults are currently paying off an auto loan.
As a result, it’s crucial that you find out your credit score before you even start looking for a car, as it determines how much interest you will pay on top of your original auto loan. While there is no minimum credit score to buy a car, a good credit score will result in a lower interest rate, while a bad credit score will likely cause that annual interest rate, or annual percentage rate (APR), to skyrocket.
What Is Your Credit Score, and How Is It Determined?
Your credit score is determined by a number of factors that appear in your credit report, which is a detailed account of your credit history. The two primary credit scoring systems, FICO and VantageScore 3.0, use five areas to determine your credit score:
- Payment history
- Credit utilization
- Length of credit history
- Types of credit
- New credit/inquiries
Based on these criteria, the three major credit reporting bureaus — Equifax, Experian, and TransUnion — assign consumers a credit score between 300 and 850, with 300 being the lowest, and 850 being the highest.
Why Does Your Credit Score Matter When Buying a Car?
While you can get a car loan with bad credit (and sometimes no credit at all), having a good credit score before you decide to explore auto financing could save you thousands in the long run. This is because loan rates are primarily determined on how likely a lender believes the borrower to be.
If you have excellent credit, auto lenders deem you much more likely to pay back their money and will charge you less as they’re assuming less risk. On the other hand, if you have poor credit, a higher interest rate will likely follow. In fact, interest rates on auto loans can range from around 3% for those with good credit buying new cars to above 20% if you have poor credit and are buying a used car.
Let’s say Emily has excellent, or superprime credit, between 781-850. She decides to take out an auto loan for $20,000 at the average new car loan rate of 3.68% with a 60-month loan term. Over the course of the loan, she would pay $1,926.96 in interest payments.
Tim, on the other hand, has a poor credit score of 660. He also decides to take out a $20,000 auto loan for 60 months, but at the average interest rate for non-prime credit scores — 11.89%. Over the course of his loan, the total amount Tim would pay would include $4,056.94 in interest — over $2,100 more than Emily.
How Can You Improve Your Credit Score?
As you can see, getting your credit score higher can have definite monetary benefits. While credit bureau Experian reports that the average credit score for a new car loan was 713, with the average credit score for used car loans being 656 — it is always in your best interest to improve your credit score as much as possible before deciding to purchase a car.
There are several things you can do to improve your credit:
- Pay your bills in full and on time
- Keep your credit utilization ratio below 30%
- Don’t close old credit cards
- Check your credit report for errors
And finally — be patient. The three credit bureaus update your credit report once every 30 days, but it can take time for your score to improve greatly. And if you have no credit score at all, it can take anywhere from three to six months for the bureaus to gather enough information to generate your report.
Step 2: Determine an Affordable Monthly Payment
First of all, you need to determine how much car you can afford. To make sure you don’t take out a loan that requires a higher monthly loan payment than you can comfortably pay each month, you’ll first need to determine your monthly take home pay. To do this, subtract your annual tax bill from your annual gross income and divide by 12. For instance, if you make $50,000 a year, your calculation might look something like this:
($50,000 taxable income – 22% tax rate) / 12 = $3,250 monthly net income
Now that you know how much money you have to work with on a monthly basis, you can figure out how much you can afford to pay each month on a car loan. Conventional wisdom would recommend that you spend no more than 10% of your monthly take-home pay on car payments, while financial advisors also recommend that total car expenses — including things like insurance costs, gas, registration fees, and maintenance — should not exceed 15% to 20% of your monthly net income.
Using the calculation above, that means your monthly auto loan repayments should not exceed $325, while additional car expenses should not add another 5% to 10%. In other words, your total monthly car-related expenses should stay under $650.
Once you know your monthly payment number, stick to it. After all, car dealerships and lenders are not in the business of helping you make good financial decisions. They will try to push you toward the largest car purchase, or largest loan they think you will be able to pay back, so don’t get pushed into buying a more expensive car, or taking out a larger loan.
Step 3: Save Up for Your Purchase
Next, after you’ve improved your credit and determined how much car you can afford, you’ll need to save up for a down payment. The more money you can put down on the purchase price of the car, generally the lower the interest rate and the shorter the term. Both of these things can save you thousands in the long run.
However, there is one caveat. While a higher down payment is certainly an advantage when it comes to buying a car, be sure not to deplete your emergency savings in order to get the car you want. Always keep at least three to six months’ worth of expenses in reserve in case of — you guessed it — an emergency. That means if you spend $2,000 each month on necessities like rent, insurance, and food, you should have anywhere between $6,000 and $12,000 — at a minimum.
In general, financial experts suggest a minimum down payment of at least 10% — although 20% is recommended — on a car purchase to capture the lowest interest rates and best financing options available on your auto loan. Keep in mind that if you already have a car, using it as a trade-in can help you reach your down payment goal.
With this information in mind, as well as the maximum monthly car payment you already determined, you can now figure out how big of a car loan you can reasonably take out.
Step 4: Get the Best Loan for You
There are plenty of financial calculators out there to help you determine a car loan amount that is best for you. But when it comes to getting the best auto loan for your financial situation, there are three primary factors you need to consider:
- The original amount of the loan
- The interest rate
- The total length of the car loan
In order to determine a principal balance on your loan that you can comfortably afford — and in turn the type of car you should buy — let’s revisit our example from above that assumes the maximum monthly payment you can afford with your net monthly income is $325.
Let’s make a few more assumptions as well. Let’s say you have a decent credit score of 713 and have been able to save $2,000 as a down payment on a new car. As a result of improving your credit score, you are looking at a loan term of 60 months with a 3.27% interest rate. With these numbers as inputs, we can then use our car affordability loan calculator to determine the maximum purchase price of about $20,000.
Once you’ve determined a healthy loan amount, do your best to get the lowest interest rate possible. Even a few tenths of a percentage point could net you thousands of dollars in total savings. Of course, your credit score is the primary influencer when it comes to the auto loan rates lenders will be willing to offer you.
There are a variety of auto lenders now available, ranging from a traditional bank loan, to credit unions, and even online lenders that extend car loans — which can help the average consumer get competitive rates when it comes to car financing. In any case, it is worth your time to do some comparison shopping to get the best rate available to you.
The length of the car loan — ultimately this is the total number of payments — will also have a strong impact on how much money you end up spending in interest. Continuing with our example, you can see that over the course of the 60-month loan you would pay over $3,000 in interest. But when you reduce the total number of months on the original loan amount from 60 months to 36, the amount of interest paid would drop substantially. In fact, your interest savings would be almost $2,000. With this in mind, we recommend staying away from any loan term longer than 60 months for new cars, and 36 months for used ones.
Step 5: Time Your Purchase Wisely
Once you’ve completed all the steps above, you’re ready to pull the trigger…but wait. Did you know that if you time your purchase effectively, you could maximize your savings above and beyond just your auto loan rate?
That’s right. There are certain times of the year, as well as certain times of the month and even week that could result in quite a bit of savings on your car purchase.
The best time of year for your purchase is near the end of the year. If you can wait until October, November, or December before you decide to go in to the dealership for a test drive, you might get a good deal that could save you hundreds, if not thousands of dollars.
This is because car dealerships and the automakers that supply them need to make their sales goals before the end of the year, and also need to get the previous model year off the lot to make room for the new model year cars coming through. As a result, Christmas and New Year’s Eve are often the holidays of choice for a car dealership’s end-of-year deals.
If you can’t wait, there are other holidays that might land you a good deal. Federal holidays and three-day weekends are notorious for offering some of the best sales available. Among the best holidays for car sales are:
- Presidents’ Day
- Memorial Day
- Fourth of July
- Labor Day
- Thanksgiving (Black Friday)
However, if none of the holidays mentioned will fit into your new (or used) car buying schedule, at least wait until a Monday near the end of the month. The first day of the week is a strategic choice, as most dealerships are overwhelmed with foot traffic on the weekends. On Monday, demand falls abruptly and prices tend to drop — even if only a little. If that Monday is near the end of the month, even better, as salespeople will be looking to meet their monthly quotas and are likely more open to the idea of giving you a better deal.
Step 6: Enjoy Your New (or New-to-You) Car
Once you’ve completed steps one through five, you can be confident not only that you can afford the car you’ve purchased, but that you’ve also gotten the best deal available. So when you drive off the lot, be sure to enjoy the wind in your hair (even if only figuratively) as you ride off into a life of mobility and endless possibility.