Four steps to take before buying a car

If you buy a new car that you trade in every couple of years, the cost breaks down to about $2 per mile if you drive the U.S. average of about 13,500 miles a year. For one year, that's $27,000. On the other hand, a used car that you buy and drive until it stops running can cost just 17 cents per mile. That comes in at about $24,000 less — at $2,295 per year.

• See also: Cost of a car loan tool

1. Set a budget before you shop. 

Keep your car-related expenses less than 10% of your gross income, your pay before taxes and other things are taken out. That includes all car costs — insurance, gas, maintenance, parking, car payments, etc. If you make $3,000 each month before taxes, your car payment should be $300 or less.

• See also: Budgeting

2. Consider paying for the car in cash. 

Not enough people do this, but it's a habit that many financially secure people follow. One benefit is that you really see the total cost when the money vanishes all at once from your checking account. It's actually the lowest possible cost, because you won't pay any interest on a loan. You might think a little harder about it and budget for a less expensive car. Car dealers know this, which is why advertisements and car salesmen phrase it as "$199 per month" rather than the total cost you'll pay over the years of a car loan or lease.

If you don't have enough money available to pay in cash and can afford to wait to buy your car, create a saving plan. Calculate the cost of the car you want to buy and the monthly payment you can afford, using a three-year loan. Save that monthly amount in a savings account and buy the car when you have the full amount. That way you can avoid paying interest on a loan and actually earn a little interest in savings, instead.Do this once, and you can repeat the cycle over and over for the rest of your life. The key is getting the cycle going the first time.

• See also: Saving, Save for a goal tool

3. Get Insured.

Once you've picked a couple cars you're interested in, call your insurance company and get a quote for coverage. If you're financing the car, be sure to include whatever coverage will be required for the loan. Insurance costs can be a deal-breaker for younger drivers because sportier cars with poor collision histories can have very high insurance rates. Also, if you have points on your license, it might limit your car options quite a bit because of the insurance situation. Adjust the price you can pay for the car accordingly, sticking with that 10% rule of thumb.

Also make sure insurance will be in place the minute you take title to the car. Call your insurer to figure this out. An uninsured car is a total loss for you and even a day's gap in coverage could lead to a problem.

• See also: Car insurance

4. Shop around for the best loan.

Shop around for auto loans because you don't need to finance the purchase from the place you buy your car. Check out credit unions in your area, which can offer better rates than banks or dealers.

• See also: Car loans

Three steps to take when buying a used car

If you're always driving new cars and replacing them frequently, you're bearing the brunt of this cost. Instead, be smart and buy a car that's a couple of years old. Insurance will be cheaper too (maintenance can be a bit higher, but surprisingly not by all that much). Over a lifetime, you could shave 40% off your car cost.

The second you drive a new car off the lot, you're upside-down. The car loses value and you get stuck paying the full price of the loan.

1. Have it inspected.

When you are buying a used car, look for pre-owned, certified cars. If possible, also get it checked out by a local garage that you trust. It's worth the small amount of money they'll charge to make sure you aren't buying into some big repair bills. If you're buying from a dealership, the dealer will inspect the car and give you a report, but it's always good to get a second opinion. If you're buying from an individual seller, don't make any agreements until you've had the car fully inspected by your own mechanic.

2. Check the vehicle history.

Get a vehicle history report service to check the history of any used vehicle you're buying.  Here are some sources:

• Carfax: www.carfax.com
• AutoCheck: www.autocheck.com
• Unofficial DMV Guide: www.dmv.org

There are really talented auto detailers out there who can take a crashed car and polish it up so that it looks brand new. But if the engine's been flooded, the frame has been damaged or the car has been in a major wreck — you're buying something that might not run for long. A vehicle history is the only way you can be sure the car you're considering is as good as it looks.

3. Check the maintenance history.

Check the car model’s maintenance history. You don't want to be stuck with a lemon that runs up big repair costs. Here are a few sources:

• Cosumer Reports: www.consumerreports.org
• Edmunds: www.edmunds.com

Four steps to take when buying a new car

If you're not sure a used car is right for you and you're willing to take the loss on a new car — there are a few things you can do to make sure you get the best deal.

1. Understand all the jargon around new-car pricing. 

Terms like invoice price, dealer hold-back and Manufacturer's Suggested Retail Price (MSRP) will come up. In general, you should shoot for paying invoice price or lower, but that may not always be possible.

• MSRP
  The MSRP is the price that the car manufacturer recommends dealers sell it for.

• Invoice price
  The invoice price is what the dealer paid the car manufacturer for the car.

• Dealer hold-back
  Dealer holdback is a percentage of either the MSRP or invoice price of a new vehicle (depending on the manufacturer) that is repaid to the dealer by the manufacturer.

2. Avoid "hot" cars that dealers are selling at a premium to sticker price.

When cars are in high demand and dealers can't keep enough on the lot — this is a trend that will end very quickly. There's no need to overpay for what is already an expensive purchase. When cars go into this kind of demand, the manufacturers always respond by increasing production. Soon, there will be plenty of cars on the lot, and the prices will come back to normal. Be patient, and you'll win out in the end.

3. Beware of extras. 

Car dealers try to stack on all sorts of extras to nickel and dime you into a higher profit for them. The classics are undercoating, rust treatments, extended warranties and even small perks like a full tank of gas, a dealer-prep service or a special cleaning. Don't feel bad about pushing back on that stuff — it just adds extra, unnecessary costs.

In fact, as a part of your negotiation — try asking for extra perks like free oil changes for a year. Dealers sometimes will add these free extras as an incentive for you to buy their car.

4. Negotiate the price separately from financing. 

In addition to making money on the actual car sale, dealers also make money on the loans they try to sell you to finance your car. We recommend setting a budget for your car purchase well before you walk into the dealership and stick to it. Don't be convinced by persuasive offers. If you haven't saved up enough money to pay in cash, shop around to compare different loan providers to get the best interest rate. Here are some sources:

• BankRate: Bankrate.com
• Lending Tree: Lendingtree.com

When you choose your preferred lend, you can get pre-approved for a loan. You might get pre-approved for more than your car budget, but don't be tempted to spend the extra amount. If you can afford the monthly payment you've budgeted for, trying recalculating the numbers for different loan terms. A three-year loan is better than a five-year loan, for example, because you end up paying less in interest over the long run.

Other things to think about

In addition to the steps above, here are a few other general things to think about when buying a car:

• Watch out for scams.
  Be careful when shopping for used cars using Craigslist or other classified-ad sources. Occasionally criminals have set up scams where you show up with cash and get robbed—or someone sells you a car they don't really own. It’s not a bad idea to bring a friend, and always verify that the title is valid (title is a legal document from the DMV, usually printed on fancy paper, that shows the true owner of the car; you need this document to transfer the car to your name).

• Know the costs of leasing.
  You may have noticed we haven't really mentioned leasing. That's because we don't recommend it. Leasing costs more than buying, in the long run. You constantly own new cars, which lose value quickly, and you pay a lot on things like hidden interest costs and high mileage charges. If you prefer this method, that's fine. Just be careful because leasing often ends up being an expensive way to drive your cars.
  
  If you do end up leasing, watch your mileage. If it goes over the annual limit allowed under the lease agreement, you can end up paying a lot extra for the overage. And if your mileage is under that limit, you might have overpaid for your lease at the onset.

Words to know

Unsure about something you read? Many of the financial terms you came across in this article are defined in our financial glossary. A-Z Glossary

Links we like

Here are a couple online features you might find useful:

• Kiplinger's auto buying guide: www.kiplinger.com/guides/cars
• Consumer Reports car buying advice:
  www.consumerreports.org/cro/cars/car-buying-advice/index.htm
• Edmunds: www.edmunds.com