Auto Loans in Canada: The Good, the Bad, and the Ugly
Buying a new car is a bittersweet experience for most of us Canadians. After dreaming about all those fancy trims and powerful engines, limited budgets pull us back to reality.
This is where an auto loan can help make those dreams come true. But that doesn’t mean you should plunge into debt without weighing the pros and cons of vehicle financing.
The Upside of Auto Loans
If your credit rating is fair to good (660 and up), you have a steady source of income (preferably a steady job), and a proportional debt load, you’ll have no trouble in finding an auto loan. Responsible borrowers also enjoy other benefits when they sign up for a car loan:
- timely repayments ramp up your reputation, because 35% of your credit score is based on your payment history;
- dealer incentives might save you thousands of dollars over the term of your loan, through 0% financing or cashbacks, so keep a sharp eye out for special offers;
- account-holders may obtain preferential loan conditions from banks and particularly credit unions, as they are familiar with your financial background;
- your savings remain untouched, earning interest and ensuring peace of mind, as they’re quickly available to cover unexpected expenses or emergencies.
The Downside of Auto Loans
Even Canadians with low credit scores can finance a vehicle relatively easily – but at a higher cost. Sophisticated sales techniques can be confusing for the unwary, as they can conceal the real cost of a car through temptingly low (or even zero) down payments, with ultra-affordable monthly instalments that can be stretched out over eight years. Here’s why these offers should be avoided:
- low or no down payment means you need a larger loan, so you’ll be paying interest on more money;
- longer-term loan repayments may fit into your monthly budget, so you’ll be paying interest over more time;
- higher interest rates (up to a scorching 10%) may result in your ride costing almost 50% more than the amount you borrow and repay over 96 months.
Auto Loan Stay-Aways
When you’re comparing your vehicle financing options, always read the small print carefully and measure the possible consequences of these conditions. Two crucial points for your attention are:
- prepayment penalties can prevent you from paying off the principal balance of your loan ahead of schedule. Although this sounds like a great way of avoiding interest, it may actually cost you money, and may also prevent you from refinancing your loan at better rates;
- negative equity is what happens when your aging car is worth less than the amount still owed on your long-term auto loan. This traps you in a vicious cycle of rising maintenance and repair costs, while depreciation steadily lowers the selling price or trade-in value of your vehicle.
What About Paying Cash Instead of Auto Financing?
Digging into your emergency fund is never a good idea, especially for buying a major asset that you know is going to depreciate steadily. But if you’ve earned a generous bonus or received a windfall bequest, there are some benefits to paying cash for your wheels:
- you won’t overspend, because you know exactly how much you can fork out on your wheels;
- your credit rating might rise, as not having a monthly car payment can count in your favour for mortgage applications
- you’ll save money on loan fees and interest charges, which can reach thousands of dollars in just a few years.
Counterbalancing the advantages of buying cash, here are some of the negatives you should consider:
- not many Canadians have enough cash on hand to buy a car without dipping into their savings;
- your choice of vehicle is limited by how much cash you have to hand;
- many great deals (like cashback offers and higher trade-in values) that are available only through dealership financing agreements;
- there may be better investments available, in assets that either appreciate or carry interest.
The Bottom Line: Canadian car buyers should be realistic and stay flexible. That’s because practical budgeting may point to a smaller or older model, at least for the moment. But here’s the good news: stashing away the money you’re not spending on interest builds up an interest-earning nest egg that will help finance the car of your dreams, in just a few years.