When you thought about life after graduation, you probably fantasized about dumping that bucket that got you through school and getting into a newer, flashier and more reliable auto befitting a college graduate. But unless you handled your college finances better than most, you’ll need a good auto loan to make this fantasy a reality at a price you can afford.

Understanding car loans
  • Down payment/monthly payment
  • Interest rate
  • Term
  • Why credit score matters
  • Shop for the best deal
  • Benefits of pre-approval
  • Shop prepared

But what separates a good loan from a bad one? The critical components are down payment, monthly payment, interest rate and term.

Down payment/monthly payment

The down payment and monthly payment, the numbers that most car buyers pay attention to, are only part of the picture. It’s important that you arrange a monthly payment and down payment that fit your budget and not become a “payment buyer.” Payment buyers get caught taking a dealer’s monthly payment figure instead of setting their budget before entering the showroom. Try playing around with Bankrate’s car loan calculator to figure out how much you can afford to spend.

Interest rate

With interest rates, you want the lowest APR (annual percentage rate) possible. This rate varies depending on where you get the loan and your credit history. While it’s true that used cars offer a lot of advantages over new cars, including lower depreciation and more car for your money, expect to pay a higher interest rate when financing one.

Term

As for the loan term, most experts recommend going no longer than 48 months. You may be tempted to go longer — it will allow you to buy a more expensive car with the same monthly payment — but even if you get a relatively low interest rate, you’ll probably end up paying more in interest than you should.

And you’ll run the risk, if the car is wrecked or stolen, of owing more on the loan than the insurance company is willing to give you for the car. Some dealers and insurers offer gap insurance, designed to protect you from this, but a good rule of thumb is, if you need gap insurance, you’re probably drawing the loan out too long.

“If you can’t do 48 months at the best interest rate, move to a cheaper car,” says Anthony Giorgianni, an associate finance editor with Consumer Reports.

Why credit score matters

Now that you know what you’re looking for, it’s time to review your credit score. If it’s in the average or above-average range, congratulations; many grads come out of school up to their eyeballs in debt and with more than a few blemishes on their credit history. Even those who have been fiscally responsible may suffer from a lack of credit history. Don’t worry, just because you have a low score doesn’t mean you can’t get a good loan — you just might have to do a little more homework. (You can estimate your credit score using this FICO scoring model.)

Shop for the best deal

No matter what your credit score, the key to getting a good auto loan is shopping around. Many car buyers assume that the best place to get financing is at a dealership, but that’s often not the case. Even if you are planning to finance at the dealership, get some other offers from banks and credit unions first.

“Shop around for the financing the same way you shopped around for the car,” says Jack Gillis, Director of Public Affairs for the Consumer Federation of America and author of “The Car Book.” “You need to find out what the typical rates are for someone with your financial history.”

You can use Bankrate to research rates in your area. (Keep in mind that if you have below-average credit, you may not qualify for those rates.) Also, many lenders allow you to apply online and receive a reply within a few days or even a few hours.

Benefits of preapproval

There are a number of benefits to shopping around. First, when you go to the infamous F&I (finance and insurance) room at the dealership, where a large percentage of dealership profits are made, you have instant, valuable leverage. This is especially true for people with below-average credit, who can often get better rates from a credit union or a bank than they can at the dealership.

“Get preapproved elsewhere,” says Edmunds senior features editor Joanne Helperin. “It gives you a bargaining chip and it helps keep things simple during negotiation. You can say, ‘I’ve got this, try to beat it.'”

Shop prepared

Also, having financing arranged before stepping onto a lot helps ensure that you won’t be “upsold” to a car you can’t afford. No matter how dazzling the test-drive or how high-pressure the sales pitch, if you know you can only get a certain amount of financing, it will be easy to keep disciplined about not spending too much.

Finally, if the dealership is offering a choice between a low interest rate and a fat rebate, having a good offer from another lender will allow you to take home both the rebate check and a low-APR loan.

Claes Bell is a freelance writer based in Lake Worth, Fla.

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