What you need to know about: Buying a car

illustration of car

Buying a car involves choosing between countless options. This guide walks you through each step of the process, including every factor you need to consider before getting the keys.

Buying a car can be exciting — and freeing. For the most part, you can decide what kind of vehicle you want, and it’s all yours to cruise around and explore in.

But it’s also a big responsibility, and smart car buyers do more than show up at a dealership and point to the make and model they want. There’s a lot involved in the process, and it starts with doing your research so you understand your options and know what a realistic purchasing decision looks like for you.

You may need to read up on the choices in order to determine what makes the most sense for you and your financial situation. Ask yourself the following questions to understand more about what you want:

  • What type of vehicle do you need? Will a car provide enough functionality for you? If so, does a sedan work or would a hatchback be better? Do you need a crossover, SUV, or truck (or is that way too much vehicle)?
  • What kind of transmission can you handle? While manual-transmission cars aren’t nearly as popular as automatics, knowing how to drive one is a useful skill. If you know how to drive a stick, you can make the choice about what kind of transmission you want. Not to mention stick-shift cars sometimes cost less than automatics — and tend to deter car theft.
  • What kind of gas mileage are you looking for? Look into the makes and models that get the best miles per gallon (MPG) if you want to get the most out of every tank. If you’re environmentally conscious — or you just want to save as much as possible on gas — you might want to look at a hybrid car over a traditional gas vehicle.
  • What additional features will you actually use? All-wheel drive (AWD) can be useful if you live in a region that sees a lot of snow and ice or wet conditions. If you typically only drive on well-paved surfaces and don’t need to worry about driving in wintry conditions, two-wheel drive is probably fine. Think about situations like this anytime you need to choose features beyond the basic package. Adding on extras when you don’t need them will only increase the price you need to pay when buying a car.

Before you make any decision about AWD or two-wheel drive, manual versus automatic transmission, car or SUV (or truck), you probably want to determine if you’ll buy your vehicle new or used.

Pros of buying new Pros of buying used
You’re the first and only owner of the car, which can help you get a reliable vehicle and avoid potential maintenance issues. You can buy closer to true value (and avoid the huge drop in depreciation that happens when you buy new).
You can choose exactly what you want, right down to the details of the car’s interior. You’ll face lower overall expenses, since taxes and insurance costs will be less.
You can get the latest safety and other features, and enjoy top-notch gas mileage (even in vehicles like SUVs). You can get features and extras for less, because you aren’t paying dealer premiums and markups for more expensive packages.

As you can see, there are good reasons to consider either option. But the biggest drawback to buying new is the fact that cars depreciate in value the moment you take the keys and drive off the lot. That could mean you pay a steep premium for the luxury of being the first owner.

“When buying a car new, you purchase it at its absolute highest value point,” explains James Matthews, a financial planner based in Charlotte, North Carolina. “The manufacturer sold it to a dealer, who marked up the price for resale to you.”

Matthews says that used cars, on the other hand, already depreciated in value and more often reflect their actual retail value. Buying a car used can save you that markup, which often means keeping thousands of dollars in your pocket.

But if you’re set on getting behind the wheel of a brand-new ride, at least plan ahead and time when you buy. “On occasion, dealers get anxious to sell last year’s inventory at the end of a model year,” says Matthews. “You may be able to buy a new car for the same price as a used one that’s one to two years old.”

If you buy new, get the most for your money. Again, plan ahead and choose a vehicle you’re most likely to drive for 10 or more years. Today’s cars can easily run for well over 100,000 miles. Buying a car new makes a little more sense if you plan to drive your vehicle for its entire working life.

Whether you plan to buy new or used, you can finance your purchase if you can’t (or don’t want to) buy a car outright with cash. However, you’ll still need to come up with some amount of cash to use as a down payment before taking out a car loan.

Cathy Derus, CPA and founder of Brightwater Financial, LLC suggests putting down at least 20% if you want to finance your purchase. In addition, she cautions against spending more than 10% of your gross income on transportation costs.

Matthews adds that if you can’t afford to pay off the car loan in a few years, then the car is likely too expensive for your budget. “You don’t want to owe more on the car in three to four years than it’s worth at that time,” he explains.

But he also notes there are situations where it might make sense to put down a little less in cash. “If you qualify for low or no interest financing,” Matthews says, “putting less down may be a good strategy — if you can still afford to pay off the rest of the loan in three to four years.”

There’s nothing wrong with financing when buying a car. It can help you leverage your assets by keeping more cash in your pocket, since you pay for the car in monthly installments (rather than parting with a big chunk of cash upfront).

But before you choose to take out a loan, you need to understand the ins and outs of how financing a car works.

A car loan is money you borrow from a lender in order to buy a car. You pay that lender back over time. You need to repay the amount of money you borrowed, plus interest. Interest is the fee the lender charges for providing you the lump sum to use to make your purchase.

“Other finance charges can apply to your car loan, including document or title fees, taxes, the cost of add-on services that get financed into the loan like extended warranties or service plans, optional upgrades, or even credit insurance that pays off the loan if you pass away or are disabled,” explains Matthews. “The total cost of these items are expressed in the APR, or annual percentage rate, which is the total cost of the loan per year.”

Matthews cautions against rolling extra services you may not need into your loan, like an extended warranty or exterior scratch protection. Many salespeople and car dealers will encourage you to throw additional services and packages into the financing, but those costs can add up over time. You end up paying interest on those expenses if you put them into your auto loan along with the actual price of the car.

You have many options when it comes to taking out a car loan. Lenders include banks, credit unions, and even car dealerships themselves. So how do you choose between a traditional financial institution and the dealership — and when should you start contacting lenders?

“Most of the time, you are better off arranging your financing prior to visiting the dealership,” says Wendy Hubbard, a financial advisor and the founder of Heirloom Financial Services. “The finance department at the dealership will try hard to get you to finance through them because they frequently receive incentives for arranging the financing.”

Hubbard notes there are exceptions to this advice — times when it may make sense to finance directly through the dealer. “Sometimes, dealers will offer 0% financing,” she explains, “or other low interest options only available through the dealer that are too good to pass up.”

Talk to different banks, local credit unions, and dealerships themselves before you even consider buying a car. Ask for quotes and what offers they provide borrowers, if any.

Just be sure to get your rate quotes within a 14-day period. Lenders will pull your credit to check your credit score, and multiple inquiries can ding that score. But multiple pulls within a small window of time (14 days) count as a single check against your credit, which protects your score.

After getting quotes and seeing the options, compare the information you gathered and see what loan will give you the most benefit for the lowest cost (and interest rate).

You know the kind of car you want to buy. You saved up cash to use for a down payment. You chose a lender for your car loan. So now you’re ready to make your purchase — right?

Not so fast. There’s one last thing to do before hitting the showroom floors. You need proof of insurance before you can buy a car.

To get proof of insurance before the sale is finalized, you’ll need to identify the exact car you plan to purchase. Then, provide the car’s vehicle identification number (VIN) to the insurance company you want to buy a policy from. From there, they can provide you with proof of insurance that you can share with the dealership to finish the transaction.

The cost of car insurance will depend on several factors including your age, driving history, and what state you call home.

“If you have an existing insurance provider, it’s often as easy as contacting them and providing them the make and model of the vehicle you plan to purchase to get an idea of what your insurance costs will be,” says Matthews.

Just like you can compare rates and offers from lenders, you can compare auto policies for insurance, too. Review monthly premiums and costs by getting quotes online from various insurance providers. (This doesn’t risk dinging your credit, like the hard credit checks that lenders pull when they generate quotes on financing products for you.)

Before signing on any dotted lines, make sure you ask the salesperson these important questions at the dealership:

  • Is the car I want here, on the lot?
  • Has it ever been damaged?
  • Is there a warranty?
  • Are there any deals or offers for maintenance or repairs if I buy from this dealership?
  • What is the cash price of the car? Is it different from the financed price?
  • What is the total price of the car, including fees and other costs?
  • What are my financing options?
  • What loan terms are available?
  • What will my APR on the car loan be?
  • What additional fees and costs, outside of my car loan, do I need to pay?
  • Can I test drive the exact car I want to buy?
  • Do you take trade-ins?

On the flip side, you’ll want to avoid talking about the monthly payment you can afford with the salesperson. Focus on the total price of the car, including all fees.

If you’re buying a car used, you may want to ask additional questions like:

  • Do you have a CARFAX report for this vehicle?
  • What can you tell me about this car’s history?
  • Did previous owners smoke in the car or frequently have pets in the car?
  • Do all the windows and locks function correctly?
  • Does the stereo system work?
  • Do all the lights and signals work?
  • Is any of the glass cracked? What about the mirrors?
  • Is there any rust on the car?
  • Are the tires in good condition?
  • Is the car up-to-date on all oil changes, tire rotations, and brake repairs?
  • When was the last time the transmission was flushed (if an automatic)?
  • Do you have maintenance records?

Ask these questions outright — but also use this as your checklist when you inspect the car for yourself.

In addition to asking the questions in the lists above — and any other questions that come to mind — don’t be shy about negotiating the price before buying a car.

The best bargaining position you can have is an unemotional one that’s unattached to any particular outcome. “Always go into every negotiation feeling comfortable to say, ‘No, thank you,’” suggests Ryland King, blogger at The Hidden Green.

He also says the Kelly Blue Book is an asset to bring to any car negotiation. “Use it to find the true value of the car and show it to the seller. This lowers the tension, creates an objective negotiation, and often gets you a better deal,” he says.

Derus adds that buyers should negotiate two other things in addition to the actual price when looking at buying a car from a dealership: trade-in value and financing. “It’s important to negotiate and come to an agreement on each item separately because the dealer is always looking for ways to make a profit or recoup concessions made in other areas,” she explains.

And Matthews says to stay on the lookout for cars coming off a 36-month lease if you want to buy used. “Dealers are often willing to make a deal on price since, in effect, they get to sell the same car twice,” he says. “They collected 36 lease payments from the previous lessee, and now they can sell the same car to you. Often they handled all of the maintenance up to that point, and you can get a low mileage, well-maintained vehicle at fair market value that someone else has depreciated for you!

Annual percentage rate (APR): APR represents the total, actual cost of borrowing money when you take out a loan. It includes the interest rate, along with origination fees and other costs of underwriting the loan. APR includes compound interest on your loan plus any fees.

Down payment: The initial, cash payment you make when you finance a purchase. Lenders and car dealers are unlikely to let you finance 100% of the purchase, so you need to have a sum of cash available to put toward the purchase price. A good rule of thumb is to have 20% of the purchase price in cash to use as your down payment on the car loan.

Financing: The process of borrowing money in a lump sum from a lender in order to make a large purchase. You may want to take out a loan to borrow enough money to pay the dealer or owner for the vehicle you want to buy. Financing allows you to purchase a car without having the entire sum of the purchase price in cash, but you need to repay the lender for the money you borrowed (usually with an interest fee on top of the original balance).

Trade-in value: The amount of money, or credit, a dealer is willing to offer you to apply to the purchase price of a new vehicle. The credit is provided in exchange for ownership of your old car.

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