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Common Car Loan Mistakes in Canada

Common Car Loan Mistakes in Canada

Buying a new car is an exciting experience. You start browsing listings, test driving models, and imagining yourself cruising down the open road. But easy excitement can quickly turn into regret if you make the wrong financing decisions. According to the Consumer Financial Protection Bureau, Americans have over $1.4 trillion in outstanding auto loan debt as of March 2022. With the average new car price reaching $47,000 in 2021, it’s no wonder car loans are weighing heavily on people’s budgets.


Getting a car loan is a big financial commitment that can impact your finances for years to come. Small mistakes can cost you thousands in unnecessary interest charges or lead you to become “upside down” on your loan. Being upside down means owing more than the car is worth, making it difficult to sell or trade-in. That’s why it’s critical to avoid common car loan mistakes when financing your next vehicle purchase.


This guide will outline the top 12 car loan mistakes to steer clear of. By being an informed borrower, weighing all your options, and taking your time, you can negotiate the optimal car loan terms to fit your budget. Let’s get started so you can cruise off the dealer’s lot feeling confident instead of stressed.

 

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Not Knowing Your Credit Score

Your credit score is one of the most important factors lenders use to determine your interest rate and whether they will approve you for a car loan. The higher your score, the better your chances of getting approved and the lower your interest rate will likely be. This can translate into thousands of dollars in savings over the life of your loan.

Before even starting your car search, it’s crucial to check your credit score so you understand where you stand. You can get your credit score from a site like Credit Karma or from your bank. This allows you to see the exact number lenders will be looking at.

If your score is lower than you’d like, take time to boost it before applying for an auto loan. Pay down balances on credit cards and other debts. Ensure you don’t have any late payments on your credit report. You may be able to raise your score 50 points or more within a few months by being diligent.

Having this knowledge ahead of time prevents surprises when the dealer runs your application. You’ll know in advance whether you’ll qualify for top-tier interest rates or if you need to take steps to improve your rate. Going in blind can lead to disappointment and a higher loan cost.

 

Failing to Shop Around

One of the biggest mistakes you can make when getting a car loan is failing to shop around and compare quotes from multiple lenders. Only looking at the financing offered by the dealership likely means you’ll end up paying much more in interest charges over the life of the loan. It’s essential to take the time and effort to explore all your options.

Make sure to get car loan quotes from several different sources like banks, credit unions, and online lenders. This allows you to compare interest rates side-by-side and identify the most competitive offers. Traditional banks may offer stability but online lenders frequently have the lowest rates. Credit unions are great options for those with existing memberships.

To streamline the process, use online tools and marketplaces like RateGenius or LendingTree to get matched with customized loan offers from a wide range of lenders. These services allow you to complete one application form and receive multiple quotes for easy comparison. Taking this broad shopping approach can mean paying thousands less over the loan term.

Don’t just settle for the first loan you’re offered. Spend time upfront gathering quotes from a diverse mix of lenders. A small difference in interest rates can really add up, so shopping around now ensures major savings down the road.

 

Choosing the Wrong Loan Term

One of the most important decisions when getting a car loan is choosing the right loan term. The term refers to the length of time you have to pay off the loan. Longer terms of 72-84 months have become increasingly common, but they often lead to paying significantly more interest over the life of the loan.

Longer loan terms mean the monthly payments are lower, but you end up paying more in interest charges over the full term. For example, a $20,000 loan at 4% interest would cost around $1,600 in total interest for a 36-month term. But stretch that to 72 months and the interest paid nearly doubles to $3,200. Going with the shortest term you can afford keeps overall costs down.

As a general rule, 36-48 months is ideal for new cars, while 24-36 months is better for used cars. New cars don’t depreciate as quickly so longer loans make more sense. Used cars depreciate faster, so you don’t want to end up underwater on the loan by going too long. Make sure to crunch the numbers to find the shortest term that fits your budget.

The pros of shorter terms are lower interest costs and paying off the loan faster. The cons are higher monthly payments. Longer terms have lower payments but cost more overall. Find the right balance for your situation. Avoid very long 72-84 month loans if possible, as you may end up owing more than the car is worth if you want to sell or trade it in later.

 

Not Considering All Financing Options

When shopping for a car loan, many buyers automatically think of traditional financing from a bank or credit union. However, there are several other options that provide more flexibility or lower long-term costs in certain situations.

Leasing a new vehicle is an alternative to buying that comes with lower monthly payments. You essentially rent the car for 2-4 years and give it back at the end of the lease term. This avoids having to pay off a loan or trade in the vehicle. Leasing is best for people who want a new car every few years and drive less than 15,000 km per year.

Secured loans use collateral like a savings account to guarantee the loan amount. They often have lower interest rates than unsecured loans. Secured car loans make sense if you have significant savings but want to keep your money invested while financing the car.

Manufacturer incentives like 0% financing deals can provide very low interest rates. This incentive is contingent on qualifying credit scores and works best for buyers with great credit. 0% financing results in the lowest total loan costs if you take advantage of the full term before paying it off.

Carefully comparing all these options allows you to find the most suitable and affordable financing for your situation. Don’t overlook a choice that could save you thousands over the life of your car loan.

 

Rolling in Negative Equity

Negative equity occurs when you owe more on your current car loan than the car is worth. This typically happens because vehicles depreciate quickly in the first few years after purchase. If you trade in a car with negative equity for a new one, that leftover debt gets added to the new loan amount.

For example, say you bought a car for $30,000 two years ago. The car is now worth $18,000, but you still owe $22,000 on the loan. That’s $4,000 in negative equity. If you trade it in for a $25,000 vehicle, the new loan would be for $29,000 – the price of the new car plus the $4,000 you still owed.

Rolling in negative equity leads to higher monthly payments because it increases the total amount financed. It also means you’ll continue paying interest on the old loan that should have been paid off already.

To avoid this costly mistake, work on paying down your current loan as quickly as possible. Or, save up a larger down payment to help offset the negative equity before financing another vehicle.

Use an auto loan calculator to estimate the extra costs of rolling in negative equity. For example, on a $25,000 loan over 5 years:

 

  • With no negative equity, total interest paid is $2,571
  • With $4,000 negative equity, total interest paid jumps to $4,012

 

That’s an extra $1,441 in interest charges because of the higher principal amount – a huge and unnecessary expense.

 

Rushing the Car Buying Process

One of the biggest mistakes people make when getting a car loan is rushing through the process. With the excitement of getting a new vehicle, it’s easy to gloss over important details or make snap decisions. However, taking your time to understand all the options is crucial for negotiating the best possible deal.

Before even visiting a dealership, get pre-approved for financing from your bank or credit union. This allows you to know your budget and interest rate ahead of time, rather than relying on what the dealer offers. It also gives you leverage to potentially negotiate a lower rate with the dealer if they can beat your pre-approval.

During negotiations, don’t let yourself get pressured into accepting a deal right away. Salespeople may use tactics to get you to sign without considering all the numbers. Take your time to carefully go over the purchase price, loan terms, fees, and extras. Don’t be afraid to walk away and compare offers from other dealers if you’re not satisfied.

Having patience allows you to make the most informed decision when securing auto financing. Know what monthly payment and interest rate you can afford before even walking onto the lot. Shop around between multiple dealers to leverage the best deal. Avoid snap judgements, and take your time understanding every detail of the transaction.

 

Not Budgeting Properly

One of the biggest mistakes when getting a car loan is not properly budgeting for the purchase. Many buyers simply look at the monthly payment amount and determine if they can squeeze that into their budget. However, owning a vehicle involves much more than just the loan payment.

To properly budget, you first need to calculate an affordable monthly payment based on your income, existing debts, and expenses. As a general rule, your total vehicle expenses including the loan payment should be less than 10-15% of your take home pay. Next, you need to factor in other ownership costs like:

 

  • Insurance – On average this adds $100-200 per month.
  • Fuel – Calculate expected mileage and current gas prices.
  • Maintenance and repairs – Set aside at least $50-100 monthly.
  • Registration, taxes, fees – Check with your local DMV.

 

Add up all these amounts to get your total monthly cost. Compare this to your monthly budget to see how much you can realistically afford. Being diligent now will prevent being stuck with painfully high payments later.

Here are the key steps for creating a car buying budget:

 

  1. Calculate affordable monthly payment based on income and existing debts.
  2. Estimate insurance, fuel, maintenance and repair costs.
  3. Research other ownership expenses like registration fees.
  4. Add up all costs to get total monthly vehicle budget.
  5. Adjust budget as needed until it fits within your available income.

 

Taking the time to properly budget prevents many headaches down the road. You’ll buy a vehicle you can actually afford, avoiding the need to constantly scrape for each monthly payment. Stick to your budget, and enjoy your new car instead of being stressed by it.

 

Focusing on Monthly Payments

When taking out an auto loan, it’s easy to get caught up in the monthly payment amount without considering the full financial picture. However, focusing too narrowly on lowering your monthly payment can end up costing you thousands more in interest charges over the life of the loan.

The reason being – lower monthly payments are often tied to longer loan terms, which means you’ll be paying interest for more years. For example, stretching a $20,000 loan over 6 years instead of 4 years may drop the monthly payment by $100. But in the end, you’ll pay nearly $1,600 more in total interest.

Use an auto loan calculator to see how the loan term impacts interest paid over time. For instance, a $20,000 loan at 4% interest will cost:

 

  • $347 per month over 6 years, totaling $24,864
  • $460 per month over 4 years, totaling $23,272

 

That’s $1,592 in extra interest for the longer 6 year term, even though the monthly payment is lower. Keep your eye on the overall loan cost, not just what fits your budget each month. Taking a shorter loan term or putting more money down can minimize interest fees.

 

Not Having a Down Payment

Putting down a down payment when financing a car purchase is highly recommended. A down payment reduces the amount you need to borrow and can result in a lower interest rate from lenders. Here are some of the main benefits of having a down payment:

 

  • Lower monthly payments – With less borrowed, your monthly payments will be lower.
  • Lower interest rates – Down payments signal to lenders that you’re financially responsible, allowing you to qualify for better rates.
  • Build equity faster – Your loan balance will be lower so you build equity with each payment instead of just paying interest.

 

You have several options for funding a down payment. The most common sources are:

 

  • Trade-in value – Selling or trading your current vehicle can lower a purchase price.
  • Savings – Money set aside in accounts specifically for a down payment.
  • Sale of other assets – Cashing out investments, recreational vehicles, etc.

 

Experts recommend a 20% down payment if possible. However, 10-15% is also reasonable for most buyers. Even a few thousand dollars down can make a difference in loan terms. For a $30,000 vehicle purchase, aim for at least $3,000 as a starting point.

 

Paying Dealer Fees

One of the biggest costs that car buyers overlook are dealer fees. These fees, also known as doc or documentation fees, are charged by the dealer to process the sale. Doc fees cover the dealer’s administrative costs for paperwork, but have ballooned in size over the years and can be several hundred dollars.

Some key tips for reducing dealer fees:

 

  • Know the maximum doc fee allowed in your state – they range from $0 in states like California to over $1,000 in others.
  • Negotiate to reduce the fee or eliminate it completely as part of the overall deal.
  • Be ready to walk away if the dealer won’t budge on a high doc fee.
  • Consider shopping across state lines if nearby states have lower maximums.

 

Always factor dealer fees into the total price, as they can have a big impact on your overall costs. With preparation and negotiation, you can minimize this major fee and keep more money in your pocket.

 

Adding Unnecessary Extras

When purchasing a new vehicle, dealerships will often try to sell you on additional products and services beyond just the car itself. This includes things like extended warranties, GAP insurance, fabric protection, and more. While some of these extras can provide value in certain situations, many are overpriced and unnecessary. Before agreeing to any additional items, it’s important to assess whether they truly fit your needs and budget.

Extended warranties that add on several years or extra mileage can provide peace of mind, especially for less reliable vehicles prone to repairs. However, they come at a significant additional cost. For a new car with a strong factory warranty, an extended warranty likely won’t be worth it. But if you plan to keep an older used car long-term, the extra protection could be beneficial.

Guaranteed Asset Protection (GAP) insurance helps cover the difference between what your car is worth and what you still owe on the loan if it gets totaled. This can be helpful if you’re making a very small down payment. But if you have substantial equity in your vehicle, you likely don’t need GAP insurance.

Other add-ons like fabric protection, rust-proofing, wheel locks, and service contracts are typically overpriced at dealerships. Be wary of any extras being presented as an absolute must-have. Be prepared to politely but firmly say no to items you don’t see value in.

The best way to avoid unnecessary extras is to do your research ahead of time. Check third-party sites to see what extended warranties or GAP insurance would cost elsewhere. This will help you determine if the dealership’s price is inflated. Also, take time to understand what extras you can reasonably afford within your budget. Don’t make rushed decisions about add-ons under sales pressure.

 

Not Checking Interest Rates

One key mistake that car buyers often make is neglecting to verify the interest rates they actually qualify for before signing on the dotted line. It’s easy to get drawn in by tantalizing advertised rates like 0% financing or 1.9% APR. However, the fine print on these deals reveals that not everyone will qualify for the lowest rates. Rates are based on your credit score and other factors. If you see an attractive teaser rate but don’t confirm you’ll actually receive that rate, you could be in for a rude awakening later.

This issue has become particularly problematic in light of recent interest rate hikes by the Federal Reserve. Average new car loan rates are now over 5%, used car rates are even higher, and buyers with poor credit pay exorbitant rates. It’s not wise to just trust you’ll get a great rate without verifying beforehand. Make sure to check your actual rate offers before settling on a lender. Getting quotes from multiple sources like banks, credit unions, and online lenders can give you an accurate picture of what interest rate you can really expect. Knowing the true rate you qualify for makes comparison shopping more effective.

By confirming your actual interest rate offers before finalizing the financing, you avoid surprises down the road. Don’t just rely on the advertised rates you see or assume you’ll qualify for the best deals. Running the numbers on the interest rates you are truly eligible for helps you make the most informed decision when financing your next vehicle.

 

Being Upside Down on a Trade-In

Being “upside down” on your existing car loan refers to a situation where you owe more on the loan than the car is currently worth. This often happens because vehicles depreciate rapidly in the first few years after purchase. If you still have a large loan balance remaining when you go to trade in your used car for another one, you can end up in negative equity.

Rolling over negative equity from your old car into a new auto loan is risky for several reasons. First, it increases the amount you need to finance for the new vehicle and can bump you into a loan term that is too long just to keep monthly payments affordable. It also likely means you’ll pay a higher interest rate because lenders view you as higher risk when you have negative equity. Most importantly, starting your new loan underwater puts you at greater risk of being stuck with an upside down car again when it comes time for the next trade-in.

To avoid this expensive cycle, here are some tips:

 

  • Make larger down payments to keep loans balances low
  • Pay down principal aggressively on existing loans
  • Sell privately rather than trading in to maximize sale value
  • Save up a lump sum to pay down negative equity before getting a new loan
  • Choose loan terms that match the car’s useful lifespan

 

With some planning and discipline, you can avoid rolling thousands of dollars in negative equity into your next car purchase. This will save a lot of money in interest charges over the long run.

 

Conclusion

Getting the best possible deal on a car loan requires research, patience and self-awareness. Avoiding the key mistakes outlined in this article – such as not knowing your credit score, failing to shop around, choosing the wrong loan term, rolling in negative equity and rushing the process – will help keep more money in your pocket while getting the wheels you need.

Educating yourself on all the financing options, taking the time to negotiate, and going into the car buying process with eyes wide open are critical. Don’t let the excitement of a new vehicle cloud your judgment. Stay focused on the bottom line and be willing to walk away if the numbers don’t make sense.

The most important thing is taking control of the situation. Now that you know what mistakes to avoid, you can feel empowered when visiting the dealership. Do your homework, evaluate all choices carefully, and don’t be afraid to push for the best deal. Your next car is waiting, at a price you can afford!

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Questions About Common Car Loan Mistakes

Yes, you can dispute a car loan in Canada if you find an error on your credit report related to the loan. Contact the credit reporting agency (Equifax or TransUnion) and file a written dispute explaining the error. They are legally required to investigate within 30 days. If they agree it’s an error, they must remove it from your report.

You have a few options if you want to get out of a car loan you can no longer afford in Canada:

 

  1. Refinance the loan – You may be able to get a lower interest rate with better terms by refinancing with another lender. This requires good credit and income.

 

  1. Trade in the car – You can trade in the car for a cheaper one and roll any negative equity from the old loan into a new loan. This will lower payments but increase total interest paid.

 

  1. Voluntarily surrender the car – You give back the car and the lender sells it. You still owe the deficiency balance between sale price and remaining loan balance. This damages credit badly.

 

  1. Consumer proposal – A negotiated settlement where you pay back a percentage of what you owe over several years. This stays on your credit report for 3 years after completion.

 

  1. Bankruptcy – This eliminates most debts but badly hurts your credit for 7-10 years. It should be a last resort option.

 

Here are some key car loan mistakes to avoid in Canada:

 

– Not checking your credit score and report for errors first

 

– Focusing only on monthly payments rather than total loan cost

 

– Agreeing to a loan term longer than 5 years

 

– Rolling negative equity from your trade-in into the new loan

 

– Not comparing interest rates from multiple lenders

 

– Paying unnecessary fees for extras like extended warranties

 

– Providing incorrect income information on your application

 

– Rushing into a car purchase without researching all options

 

 

There are a few reasons why your auto loan amount may exceed the car’s purchase price in Canada:

 

– You rolled negative equity from a previous car loan into the new loan – this carries over what you still owed on the trade-in.

 

– You financed extras beyond just the car price, like an extended warranty, GAP insurance, or maintenance package.

 

– The loan includes sales taxes and other fees rolled into the amount borrowed.

 

– The dealership inflated the vehicle price or loan amount to earn bigger commissions.

 

– You have a very high interest rate driving up the total amount owed over the loan term.

 

Always read your loan agreement carefully to understand exactly what you are financing on a new car purchase.

As of March 2023, the average interest rate on new car loans in Canada is around 7.5% for terms between 2-5 years. Used car loans tend to be 1-3% higher on average. Rates range from under 3% for buyers with exceptional credit scores up to over 15% for high risk borrowers. Prime lending rates in Canada directly impact auto loan rates.

Your credit score has a very significant influence on the interest rate lenders will offer you on a car loan in Canada. The higher your score, the lower your rate will be. Here’s an estimate on rates based on your credit tier:

 

Excellent credit (720+): 3-5%

Good (680-719): 5-8%

Fair (620-679): 8-12%

Poor (<620): 12-20%

 

Improving your credit score before applying for an auto loan can therefore make a big difference in how much total interest you pay. Check your score several months ahead of time to give yourself a chance to boost it first through responsible credit management.

Yes, getting pre-approved for an auto loan before visiting dealer showrooms is highly recommended in Canada. Pre-approval locks in an interest rate and loan amount based on your credit and income proof. This gives you strong negotiating leverage on the car price itself. Pre-approval also ensures you won’t get stuck with a higher rate at the last minute after you’ve already fallen in love with a car. Give yourself at least 2 weeks for the pre-approval process.

 

Financial experts generally recommend limiting your car loan term length to a maximum of 5 years (60 months) in Canada. Shorter terms of 2-3 years are even better for saving on interest charges over time. The longer the term, the more total interest fees end up getting added to the principal amount borrowed. Keep the term as short as comfortably fits your budget.

 

Yes, making a reasonable down payment on a car purchase in Canada can significantly reduce your auto loan amount, interest charges, and payments. Aim for a minimum of 10-20% as a down payment if possible. This also helps ensure you don’t end up “upside down” on the loan owing more than the car is worth. Even just $2,000 or $3,000 upfront makes a worthwhile difference on most car loans.

Be on the lookout for these common fees when financing a car purchase in Canada:

 

– Documentation fee – Up to $300+

 

– Lien registration fee – $15-$60

 

– Extended warranty cost – Can add over $2,000

 

– Dealer prep charges – Around $600 typically

 

– GAP insurance – Around $600 on average

 

– Interest charges – Can really add up over a 5+ year loan

 

Read all documentation carefully and know what each fee is for before signing your auto loan contract. Don’t hesitate to negotiate or decline unnecessary extras.

Yes, new immigrants to Canada can qualify for a car loan typically after 6 months if they have proper work permits, local job income, a valid Canadian driver’s license, and ideally some established Canadian credit history indicating responsible repayment patterns. Use a secured credit card initially to start reporting positive payment history to Canadian credit bureaus. After 2+ years of steady full-time local employment, approval chances increase significantly for reasonable auto loan rates.

Most Canadian lenders will approve you for a maximum car loan amount equal to around 50% of your gross annual income. So for example:

 

Gross Income – $60,000

Max Loan Amount – $30,000

 

Higher income individuals may qualify for slightly higher multiples based on strong credit scores and manageable existing debts. But a 2:1 income to loan ratio or lower is a good general guideline for the highest loan amount you can reasonably afford.

It is typically quite difficult to qualify for an auto loan if receiving social assistance or disability payments as your main source of income in Canada. Most mainstream lenders will require full-time verifiable employment income of at least $2,000+ per month to consider issuing an auto loan, even if you have good credit. However, some specialized subprime lenders do cater to non-traditional borrowers on social assistance and may offer financing options, although at much higher interest rates and payments compared to standard car loans.

Here are some types of auto lenders you may want to steer clear of when financing a vehicle purchase in Canada:

 

– High pressure, “buy here pay here” dealership financing

 

– Subprime lenders advertising guaranteed approvals no matter what

 

– Lenders who won’t provide full loan details upfront

 

– Companies offering auto loans over 8 years

 

– Lenders trying to bundle unnecessary extras into the loan

 

– Any financier demanding immediate payments to “lock in” offers

 

Carefully vet and compare all loan providers on interest rates, fees, and repayment terms. Watch for red flags indicating predatory lending practices.

Yes, making additional periodic payments towards your auto loan principal in Canada can significantly reduce the total interest fees paid over the life of the loan. Even an extra $100 or $200 per month makes a worthwhile difference. First check your loan agreement – some charge early repayment penalties if paying off the balance much faster than scheduled. For most standard car loans, extra amounts can be applied directly to the principal at any time with no penalties. This saves potentially thousands of dollars in interest charges over a 5-6 year loan duration.

Defaulting on a car loan in Canada triggers serious negative financial consequences, including:

 

– Your vehicle getting repossessed by the lender to recover their losses

 

– Severe damage to your credit score and report for 6+ years

 

– Getting taken to court for the loan balance deficiency left even after vehicle liquidation

 

– Potential garnishment of your wages, income tax refunds or other assets

 

– Ineligibility for future loans due to derogatory default notations

 

If you anticipate issues making payments, immediately contact your lender in Canada to discuss options before defaulting. This may include refinancing, lowering interest rates, extending terms or negotiating partial debt forgiveness in hardship situations.

Yes, you can trade in a vehicle with negative equity from an existing car loan when buying another car in Canada. The dealer handles paying out your loan balance directly to the lienholder. Any negative equity gets rolled over into the financing on your new vehicle purchase, so you continue paying off the combined amount. Just beware this increases loan amounts and interest charges. Consider paying down more of the current loan first to minimize rollover debt before trading in.

Notify your auto loan lender right away if you lose your source of income in Canada. They may offer options like temporary payment reductions, extensions on due dates for several months, or re-amortization of the remaining loan balance over a longer repayment term to reduce payments. If you have good payment history, most mainstream lenders will work proactively with borrowers facing financial hardship due to job loss, illness or disability to help avoid an eventual default status.

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