What you need to know about car loans

Choosing a car or truck is a big decision usually made after a lot of research. However, if you're planning to borrow money to buy your next vehicle, and after you've assessed how much you should spend, you should spend time exploring lenders and their terms. If you're just starting out on your car buying journey, review our guide for how to buy a car.

Get your loan preapproved.

Most dealers are eager to offer you financing, but you may get a better rate — and could drive a better price on the car — if you come to the negotiating table prepared. You can try to get a loan approved, or preapproved or prequalified depending on the bank, in advance by the lender of your choice.

Know what you should spend.

There can be a big difference between how much you're approved to borrow and how much you should borrow. Determining this is as simple as knowing your financial situation and your goals — and not breaking your budget.

As you're budgeting, consider spending no more than 15% of your take-home pay on the total cost of owning a vehicle.

Remember: Budget for more than just the monthly payment for your car. Consider your vehicle's total cost of ownership. That includes your insurance premium, gas, maintenance costs and, in some cases, parking. Also, factor in any anticipated changes to your income over the next few years, including bonuses and cost-of-living adjustments.

Balance loan terms with affordability.

While it is typically best to keep the loan term as short as possible to avoid paying more in interest or risk being upside down in the vehicle, we are seeing historically high prices on new and used vehicles. As such, it may be more difficult to afford the monthly payment with a shorter-term loan. Be sure to balance what you want from your new car with the overall loan terms and costs.

Your credit score matters.

As with most types of borrowing, your approval to borrow and your interest rate depend in part on your credit score and history. Keep in mind, when banks or dealers advertise low interest rates, it could be a teaser rate for which only those with the best credit scores can qualify.

Loan rates only mean so much.

There's more than rates to consider. Always look at the total interest expense over the life of the loan. Since your debt may span several years, you should also evaluate the lender's reputation for providing quality service in setting up and servicing your loan.

Finally, weigh 0% offers with rebates and compare your options to determine the best deal. In most cases, you could be better off financially taking a cash rebate versus a low-rate offer. Compare all of your options when looking at which available incentive is right for you.

Your car is your collateral.

Car loans generally have lower rates than credit cards because they are a type of "secured loan." That means that you pledge your vehicle as collateral: If you don't keep up with your payments, it could be repossessed.

Be cautious of rolling extra charges into your loan.

Lenders may offer you the option to not just finance the car's purchase price, but also tax, title, license and other charges. A lower out-of-pocket expense today, however, comes at the price of higher monthly payments and more money spent on interest. You should plan to make a down payment. We typically encourage you to plan for 15 to 20% in a down payment to help pay for tax, title, licensing and to reduce the impact that depreciation can have on your loan balance versus vehicle value.

If you owe money on your current car, you may also be tempted to roll your old debt into your new loan. This is often the hidden maneuver behind a dealer's offer to "pay off what you owe" on your current vehicle.

If you do this, you increase the chances of being "upside down" on your new loan — owing more than it's worth. You also set yourself up for higher interest expenses and increase the chances you'll fall into the same expensive cycle when it comes time to move on to your next car or truck.

Just remember: It never hurts to have some financially safe alternatives. If you don't have to buy a car immediately, you can use the time to save a little money for a bigger down payment. Or, if you can't wait, think about buying a less expensive car.

Consider all your insurance options.

There's a good chance your lender will offer you more insurance options, such as credit life insurance, which pays off your loan if you die, or guaranteed asset protection (GAP) insurance. This can free you from having to pay the difference between your outstanding debt and your insurance settlement in the event of a total loss. Be sure to evaluate your overall insurance needs in the event of a death or disability and determine the best coverage for you. Shop around for other alternatives before committing.