Getting a car loan seems relatively straightforward. You figure out how much you can afford to pay each month and how many years you want to be paying it. You shop around for the best loan deal you can find and get pre-approved. Then you pick out your car, finalize the loan, and drive away. Easy, right? Well, yes—if your only goal is to get any old car loan. But if you want to get a good car loan, there are a few more steps you should take that will save you money and keep you in control of the process.
Start by reviewing your credit report and score. This will help you get a rough idea of what interest rate you’ll be charged for a loan. See if there are any negative or derogatory entries on your credit report that can be eliminated quickly to boost your credit score. Better credit = better APR.
Take a close look at your finances. Your income and monthly expenses, rather than your desire for a cool new car, should drive your decision about how large a loan to seek. Some experts recommend that you spend no more than 10% of your after-tax monthly income on a car payment, but this rule of thumb is subject to a number of other factors. Do you live in an expensive city? What do your monthly bills look like? Are you buying a car that will be especially expensive to insure or maintain? Be conservative in estimating how much you can pay each month—and don’t forget to factor in insurance, maintenance, and fuel.
Calculate how much of a loan you can safely afford, given your credit history, your income, and your expenses. There are a number of car loan calculators that make this process easy.
Figure out how to make the largest down payment you can. Putting more money down will lessen the likelihood that you will be underwater on your car loan. A larger down payment may also reduce the interest rate you pay on your car loan and save you a great deal of money.
Armed with this information, your next step is to shop for a loan. And “shop” is the right word here. An auto loan is a major purchase, one that you’ll likely pay thousands of dollars for. Treat it as such, not as simply a means to getting car of your dreams. Check with both the banks and credit unions you do business with, and also with those you don’t. Consider online car loans, especially if your credit is less than stellar. Also, make sure to ask yourself the following: Are there prepayment penalties? Are there origination fees? Can payments be made online? And—this is important—do all your loan shopping in less than two weeks. Why? Because credit bureaus knock points off your credit score every time someone does a “hard pull” of your credit history. But they treat a cluster of similar inquiries made within a two-week period as a single inquiry. In other words, they don’t penalize you for shopping around, so long as you do it quickly.
Be aware that many dealers may try to sell you a more expensive vehicle than is prudent for your budget. And they may also offer their own in-house financing deals to make it easier for you to buy a pricier vehicle. Typically, though, these deals that look wonderful in the salesman’s office come with longer payoff terms. And that means paying more interest. Not all dealer-assisted financing is a bad deal, of course. Sometimes dealers will have access to financing options that individuals do not. But be wary. A loan is only a better deal if it costs less over its lifetime.