Buying a car A step-by-step guide to everything you need to know

Alex Thomas Sadler

When you start thinking about buying a car, there are a lot of things to consider.

First of all, don’t rush it! Once the deal is done, it is NOT something that can easily be undone — at least not without you losing a bunch of money.

So to help you make the most informed decision, we’ve put together this guide that walks you through the entire car buying process from start to finish — including everything you need to consider and big mistakes to avoid.

And remember, making smart and confident financial decisions isn’t about being an expert, it’s just about having some Common Cents!

A few general things to know about buying a car:

When we talk about “smart and confident” financial decisions, part of that means avoiding doing something that you regret.

A study found that one in five car buyers regret their decision within minutes — not days, weeks, months — but minutes. And once you drive that thing off the lot, there’s no more oops or never mind.

A car is typically the second-biggest purchase most people make in their lifetime, behind purchasing a house.

Buying a car is a big deal – and involves a lot of money – so you want to be sure you know exactly what you’re getting into and that you’re making the best decision for your budget and your life.

Here’s how a lot of people end up regretting their decision to buy a car.

You browse around online, fall in love with a car and then head to the dealership. After a little bit of “haggling” — which actually just involves the sales guy pitching any and every extra offer he can think of — you drive away with your awesome new ride.

That is exactly what NOT to do.

So let’s talk about the RIGHT way to buy a car.

And keep in mind, these steps take you through everything to consider about the entire process – to ensure that you have all of the information you need to make an informed decision. Then once you have a good grasp on each part, you can put it all together to decide what’s best for you.

Step 1: Pre-qualify for a car loan

Getting a great deal on car isn’t just about the sale price, you also have to consider what you will have to pay each month and the total amount the car will cost you over time.

The first step is to prequalify for a loan, so you’ll know how much money the lender will give you and what your monthly payments will look like. Then you can figure out what your budget will allow you to afford.

If you plan to cover the entire sale price of the car in cash, then you can skip this part!

Since most people don’t have that kind of money lying around, let’s just assume that you’re going to need a car loan.

Before you even figure out how much of a down payment you’ll need, you need to know how much the bank will lend you.

You really can’t even look at price ranges until you know what kind of money you’re working with.

So make sure to get prequalified before you start shopping for a car.

Where to get a car loan

Financing can be arranged through a bank, credit union or other financial institution. The lender gives you a loan to buy the car and you agree to pay the money back over a set period of time, with interest.

Go to a credit union, local/smaller bank or online bank to get prequalified.

Credit unions and local, smaller banks typically offer lower interest rates than big banks — and much lower interest rates than any financing offer you could get through a dealership.

When you get a prequalification for a car loan, it not only gives you an idea of what you can buy, but it also allows you to go to the dealership and basically say, “hey, I can only spend up to this amount — so what kind of deal can you give me on this car I want?”

Bottom line: Get the financing figured out BEFORE you start shopping.

Then if the dealer can beat the offer you already got, great! (But that likely won’t happen.)

Limit your loan shopping period to two weeks

Every time you apply for a loan, whether you get it or use it, your credit score goes down. So when you’re applying for a car loan with different lenders, do it all within a two-week period, that way it will all count as one inquiry on your credit.

Step 2: Figure out how much you can actually afford

After you know what the bank will give you, the next step is facing reality.

When you start thinking about buying a car, you can probably already picture yourself in it. But you have to take a step back and get a realistic idea of what you can actually afford. And sometimes that may mean either waiting a few more months or buying a more budget-friendly car than you had planned.

So to figure out what you can afford, here are some important factors to consider.

1. How much down payment can you afford?

 A down payment is the money you pay upfront for a car. Ideally, you want to have 20% of the car’s sale price in cash to pay upfront at the time you buy it.

For example, if you want to buy a $20,000 car, the ideal down payment would be $4,000. When you put down more cash upfront, it will reduce how much money you have to borrow and it will also allow you to pay off the car loan quicker.

A down payment doesn’t necessarily have to be cash in the bank. If you’re trading in your old car, that money can be used toward the down payment.

You can also sell the old car yourself and use the cash to help you cover the down payment. And you’ll actually probably get more money for the old car if you sell it yourself!

You may see offers out there that require you to put very little to even no money down, but that’s a really bad idea. That’s how people end up owing more on a car than it’s even worth.

If you don’t have 20% to put down, try to have as close to that amount in cash as you can before it comes time to buy a car.

After you put cash down upfront, you’ll need to borrow money to cover the remaining cost of the car.

For example, let’s say you’re looking at a $20,000 car and you have 20%, or $4,000, in cash to pay upfront. That means you need to borrow the remaining $16,000 to be able to buy the car. If you’re looking at a much more expensive car, that means you would have to borrow a lot more money.

2. How much monthly payment can you afford?

If you plan to take out a loan to pay for the car, which most people do since the total cost would require a lot of cash, what’s the maximum amount of money you can afford to pay each month?

Take a look at your budget — if you don’t have a budget, check out our budgeting guide that walks you through how to create one — and get an idea of how much you can realistically afford each month.

And don’t max out your budget with a car loan payment — there are a lot more costs involved with owning a car.

3. How will your credit affect your ability to buy a car?

Having a good credit score will allow you to get a much better deal on a car loan.

So when you start thinking about a new car, you need to get a free copy of your three credit reports (if you haven’t already done so this year). Just go to annualcreditreports.com to request each report from Equifax, TransUnion and Experian.

Check your reports for any errors or old bills you forgot about and get them straightened out as soon as you can. This process may take a little while, but at least you will have an idea of what to expect when it comes time to apply for the loan.

Typically, what lenders consider to be a good score for a car loan is a little lower than what’s considered good for a mortgage.

But here’s what you need to be careful of when you apply for a car loan with a poor credit score: a lender may offer you a loan with low monthly payments, but it will very likely be a much longer loan — which means you would end up paying a lot more in interest and eventually owe more on the loan than the car is even worth.

On top of that, your credit will also impact your car insurance rates, and the nicer the car, the more expensive it is to insure. So just keep that in mind. We’ll get more into insurance a little further down in the guide.

4. Don’t buy too much car for your budget

There are a lot of solicitations out there for “great” deals on car loans, including offers available to people with poor credit, including people who couldn’t get a loan just a few months ago.

But what that’s done is allow people to buy more car than they can afford, which is a really bad idea.

Here’s an example of how it works: someone wants to buy a $30,000 car but can’t afford the monthly payments. So instead of buying a cheaper car, they just get a longer loan term. Sure, the monthly payments are lower, but it’ll take them a lot longer to pay off the loan — and they will actually reach a point when they owe more on the car than it’s even worth, thanks to depreciation (which we’ll get more into below).

To give you some context, the average monthly payment for a new right now is about $500! And it’s causing a lot of people big problems.

5. Do NOT agree to a longer loan term to reduce your monthly payments

When you’re going through the financing process and realize that your monthly payments will be too high for you to be able to pay off the loan in 42 months, then you’re trying to buy a car that’s more expensive than you can afford.

Forget about those 60 month or 72 month (sometimes even longer) loans that people have been getting. When you stretch the loan out that long, that’s when you end up owing more than the car is worth and the payments will just continue to eat away at your budget and savings.

So try to keep the length of the loan as short as possible.

Also, to stay within budget, you really don’t want any more than 20% of your monthly take-home pay to go toward a monthly car payment.

So when you’re considering finance offers, pay attention to the total loan amount and the amount that you yourself have calculated as how much you can afford each month. If a lender starts talking about reducing your monthly payments, it likely means they’re trying to get you to buy more car than you can afford by giving you more money and just extending your loan period. But that’s a better deal for the bank – not you – because the bank would get more payments and interest from you over time.

Bottom line here: if the monthly payments are too high for the car you want — then you’re trying to buy a car that’s too expensive — think buyer’s remorse … DON’T DO IT. Come back to Earth and reevaluate your list of cars to consider.

6. Read the fine print

Don’t sign a car loan agreement until you know exactly what you are getting into. If you aren’t quite sure what all the tiny fine print means (don’t worry, most people don’t), then ask a friend or family member who has experience with contracts or other legal agreements to look over it with you.

Step 3: New or used?

Next you have to figure out whether you want to buy a new car or a used one.

A used car will cost you less, but a new car may be more reliable and cost you less in unexpected repairs — but it really depends on the type of car, your budget and your longer-term plan.

 So there are a few things you need to consider when trying to decide on new vs. used.

1. Cost of the car.

Let’s look at two cars, same make and model — one new and one used. How much would each car cost you over three years?

  • NEW: Let’s say you find a car you love that costs $30,000 to buy brand new.
  • USED: Then you find the same exact car that’s three years old — and the price is only $15,000.

Why such a big difference in price?

One word: depreciation.

The second you drive a new car off the lot (literally, the moment you pull onto the road), that car loses 10% of its value — and with some cars it can be even more.

So let’s say you buy a brand new $30,000 car — take a look at how depreciation would impact the car’s value over three years:

  • After you drive off the lot: 10% loss = $27,000
  • After one year: 20% loss = $24,000
  • After three years: 50% loss = $15,000.

That’s a good estimate of how depreciation can impact the value of a new car, but the exact numbers depend on the type of car — so make sure to do your homework when you’re considering a specific make/model.

If you buy the used car, the one that’s three years old for $15,000, after you own the car for three years, it’ll be worth around $10,000.

So if you sell or trade in the car after three years — the new one would have cost you a total of $10,000 — while the used one would have only cost you $5,000.

2. How long you plan to keep the car

New cars lose the most value in the first few years — then over time, they lose less and less each year.

So depending on how long you plan, or want, to keep the car — that will determine what makes the most financial sense.

If you buy a new car and keep it 8 years, that’s the equivalent of buying a 2-3 year-old-old used car that you keep for 4-5 years.

Since a new car loses the most value in those first few years, to balance out the higher price, you need to keep it longer — about 8 years.

If you buy a used car that’s 2-3 years old, it will have already taken the biggest hit in depreciation, so you would only need to keep it for 4-5 years to get the most value for your money.

So if you think you will want another car in a few years, then a used car is a much better option — because you don’t take that huge loss in the first few years and you won’t lose as much money in the long run.

If you plan to buy a new car and drive it until the wheels fall off, then go for it, you will get your money’s worth even though the car cost you more.

Keep this in mind!

If you buy a 2-3 year old used car, you can get a much nicer one, because it will cost you a lot less than a new car — and then you can upgrade every few years and still get the best bang for your buck

Step 4: Insurance

Now let’s talk about car insurance.

Car insurance is just a fact of life when you become a car owner — not only is it required by law, but it also protects you and other people in the case of an accident.

When you first buy a car, you want to have it fully insured. If you don’t and something happens, you’re out of luck.

So when you start shopping for cars, you need to consider how much the car will cost you to insure, because how much you pay each month will depend on a variety of things, including the type of car you have, your credit score and several other things.

Factors that can impact your car insurance rates

Insurance rates are determined by a lot of different factors. It’s not just your driving record that insurers take into consideration anymore — they also factor in things like your education level, job title, whether you own a home or rent, and where you live.

Your credit score will also be a big factor that determines how much you pay each month for car insurance. So if your credit score isn’t too good, you will likely have to pay more each month for insurance, on top of your monthly car payment.

Insurance on new vs. used cars

The cost of repairs is a big factor in the price of car insurance. So when you’re looking at buying a new car vs. a used one, consider how much each car would cost to repair and replace. Since a new car is more valuable than a used one, it will be more expensive to insure.

This means when you’re trying to figure out how much car you can afford, you have to take into account the cost of insurance — because when you start to reach the top of your budget, that monthly insurance bill can end up causing you problems.

Choosing the right car insurance company

When it comes time to buy car insurance, it’s crucial that you shop around for the best rates and the best deal for you. (You should also revisit your car insurance every couple of years to make sure the policy is still what you need and to check if there are any better deals available.)

Consumer Reports is a great resource when you’re trying to decide which auto insurers to even consider. Start with the companies that get the highest ratings on their list of best auto insurers.

Once you have your short list of insurance companies to consider, then you want to get a price quote from each one – just make sure each quote is for the same amount of coverage, so it’s an apples-to-apples comparison.

You can get insurance price quotes online or just by calling each company directly.

Working with an insurance broker is another option. He or she will get multiple quotes for you and you’ll have access to all the insurers they do business with. The broker can help you narrow down your options and still benefit from comparison-shopping.

Setting the right deductible

When you’re setting your car insurance deductible, there are a couple of things to consider.

Having a higher deductible reduces your premiums, how much you pay each month, but it also means you have to pay more out-of-pocket in the event of an accident.

If you want to get the most savings out of your car insurance policy, your best bet is to take a higher deductible, which is around $1,000. That means your monthly payments will be lower and then you would only file claims for damage that you can’t pay for yourself.

When you file claims for small, minor damage to the car, the insurance company will increase how much you pay each month. So you don’t want to do that! You really want to limit car insurance claims to only big repairs that you can’t cover out-of-pocket.

That’s why it’s crucial to consider how much a car will cost you to repair and maintain over time – before you buy it!

The last thing you want to do is buy a car and then realize it costs you a fortune to fix every little thing! That’s a quick way to drain your savings.

Step 5: Maintenance & repairs

One of the biggest factors to consider when you’re buying a car is what the car will cost you to drive it – so all the expenses in addition to the actual sale price.

This can be tricky since repairs can be unpredictable, which is why you must do some research on any car you consider purchasing.

 You don’t want to get distracted by the great deal you’re getting on a car and then figure out that every single little thing moving forward is going to cost you out the wazoo!

While used cars are more reliable than ever these days, buying a used vehicle always comes with some amount of risk – so it’s important to pay attention to a few things that could end up making your great deal on a used car a lot more expensive than you planned.

All cars encounter issues and repairs, but some are known to have a lot more problems than others — and that’s what you want to find out before you decide on a car.

Reliability & safety

Do some research on the overall reliability of the cars you’re considering, because this can cut the cost of repairs way down over time. Unexpected car repairs can eat up a big part of you budget, so to keep the costs down, you want to make sure that you’re buying a reliable car!

You also want to pay attention to the safety record and ratings to ensure the car offers the features you’re looing for.

Consumer Reports is also a great resource to compare reliability and safety ratings of different cars, including both new and used.

Maintenance & repair costs

To keep your car in good shape, there are a few things you have to keep up with on a regular basis, which of course, cost money. There are also some common repairs you should expect with any car you buy, which also cost money.

So you want to figure out what these little expenses are going to cost you. Here are a few examples:

  • Oil changes
  • Brakes
  • Fluid changes
  • Tires
  • And other general repairs.

It’s easy to find out — just call or go to a dealership or mechanic who services the car you’re thinking about buying.

Tell them you’re buying a car and you want to know what costs you should expect – both big and small.

Warranties

With a new car, big repairs may be covered by a warranty in the first few years – but after that, you want to make sure that any future costs aren’t going to totally kill your budget.

With a used car, if it’s not very old at all it may still be under warranty. If not, you can buy a warranty to cover big repairs — just make sure you buy the car manufacture’s own warranty.

One thing you must do before buying a used car!

With any used car, you always want to have it inspected by a certified mechanic — before you buy it. They will be able to find any hidden problems or potential issues that you would need to know about before making the purchase.

This can be a mechanic you know or one that’s referred to you by a friend. But if the used car dealer refuses to let you have the car inspected by your own mechanic, take your business somewhere else!

Step 6: Choosing the right car for you

Buying a used car is a great way to own a nicer, more expensive car that you may not be able to afford brand new.

The median price for a recent model used car, one made since 2011, is about $18,000 — $10,000 less than the median price of a new car.

Your best bet is a two- to three-year-old car with the widest range of safety and latest technology features. It’s also a good idea to look for a vehicle with 50,000 miles or less that may still be under the manufacturer’s warranty.

To start narrowing down your search, check out the latest information from Consumer Reports on the best used cars and best new cars for your money.

Identify your needs

When you start looking at cars, you need to figure out what your needs are. The flashy sports car may sound awesome, but if you’re hauling kids around, strapping them to the top won’t cut it. So you have to be practical.

Here are a few things to think about that will help you narrow down your list:

  • How many seats do you need – both now and a few years from now?
  • What safety features are important to you?
  • How much parking space will you have for the car?
  • Do you need a lot of cargo space?
  • Will you need to tow anything behind the car?
  • Is fuel efficiency important to you?

Consider what exactly you need the car for and how you will use it. That will help you cross a few options off the list.

Once you’ve narrowed it down to two or three cars, or even a few more, then you need to some research on each one to figure out which option is the best for your budget and needs.

Do your homework on each car to find out:

  • Price
  • Reliability
  • Safety record
  • Other features that are important to you
  • Cost to insure
  • Other expected costs

Then figure out the dealer cost of each car with the features you want. Check out websites like Edmunds.com, KBB.com and NADA.com – they have great tools that can help you determine the value of the car.

Step 7: Buying the car

Once you narrow your short list down even further, and you have the actual dealer cost of each one, then you need to shop around online for price quotes.

Websites like CarsDirect.comTrueCar.comOverstock.comUSAA and Zag.com are great resources to find instant price quotes. Costco also has a car-buying program!

If you don’t want to buy online, use the online price quotes as a way to negotiate at the dealership. Once you have the quotes, call around to see if the dealer will match it. You can also do this over email with the dealer.

And if you want to test drive the car, just rent it for a day or two. That will give you a great feel for it before you make your final decision.

Negotiating at a dealership can be a stressful process, but if you do decide to go that route, when you go in to sign the final paperwork, just make sure to read through everything and confirm that it’s exactly what you had agreed to over email, phone or previously in person. Don’t let a dealer add on extra fees or charges you didn’t agree to or don’t want!

Another option is to buy the car through a warehouse club that has a car-buying program with pricing that’s already been negotiated. This can not only save you money, but also save you a lot of time and stress.

Final thought

 That’s a lot of information to digest. So if you’re overwhelmed, just take a step back.

Start looking at each part of the car buying process separately, and then once you do that, you can start putting the pieces together to decide what type of car is best for you and your budget.

The key is to always keep in mind how quickly all the various costs of buying and owning a car can add up. You may find that buying your dream car right now just isn’t going to happen, but that doesn’t mean it can’t happen down the road!

Buying a car with the functionality you need and that you can actually afford may not be as fun and glamorous as you had imagined. But here’s the thing — making smart and realistic decisions now is the only way to give yourself a chance of being able to afford all the things you dream about in the future.