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How Much Car Loan Can I Afford?

How Much Car Loan Can I Afford?

The gleaming exterior, that new car smell, the excitement of being behind the wheel of your dream ride – buying a new car is a thrilling experience. However, that exhilaration can quickly turn into stress when trying to determine how much you can realistically afford on a car loan.


With the average price of new vehicles in Canada reaching over $40,000 in 2022 and interest rates on the rise, it’s crucial to understand your budget and loan options before visiting dealerships. The last thing you want is to fall in love with a car, only to later realize you can’t afford the payments.


This comprehensive guide will provide Canadian buyers with a detailed breakdown of how to calculate the maximum car loan amount that works for your financial situation. Follow these tips to find the right auto loan fit so you can cruise off the lot in your new ride without breaking the bank.



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Calculate Total Monthly Vehicle Expenses

When determining how much car loan you can afford, it’s important to calculate the total monthly costs associated with owning and operating the vehicle. This includes more than just the loan payment. Be sure to factor in these common monthly expenses:

 

Auto Loan Payment

This is the monthly amount you’ll owe on the loan principal plus interest. Auto loan calculators can help estimate this number based on the vehicle price, down payment, interest rate and loan term.

 

Insurance

Liability insurance is required by law, while collision and comprehensive coverage are highly recommended. Insurance costs depend on your age, driving record, vehicle type, coverage limits and other factors.

 

Fuel

The fuel efficiency of your vehicle and your driving habits determine gas costs. Calculate your monthly fuel spending based on current gas prices and estimated mileage.

 

Maintenance and Repairs

Plan for routine maintenance like oil changes and tire rotations, plus unexpected repairs. Budget $50-200 per month for maintenance costs depending on the vehicle.

 

Registration, Licensing Fees

These annual fees to register your vehicle and renew your driver’s license need to be broken down into monthly costs. Expect $10-40 per month in licensing and registration costs.

Add up these key monthly expenses to understand your total vehicle costs. This gives you a clear picture of what you can realistically afford each month for a car loan payment.

 

Determine Your Down Payment

When purchasing a new or used vehicle, experts typically recommend putting down at least 10-20% of the total cost as a down payment. The more money you can put down upfront, the lower your monthly payments will be since you have less principal to finance. There are a couple ways to come up with an adequate down payment amount:

 

  • Save up over time – Start budgeting and setting aside a portion of each paycheck specifically for your vehicle down payment. It may take many months or even years to save up 20% of the total vehicle cost, but this approach allows you to buy the car fully in cash.
  • Trade-in your current vehicle – The trade-in value you receive from the dealership for your old car can directly go towards the down payment on your new vehicle. Ideally, you would still have additional savings to put down beyond the trade-in value.

 

Putting down less than 20% will increase your monthly payments, but may be more feasible depending on your current financial situation. Just try to put down as much as you can reasonably afford. The larger your down payment, the less you have to finance which saves substantially on interest charges over the loan term.

 

Understand the 20/4/10 Rule

When determining how much car loan you can afford, financial experts often reference the 20/4/10 rule as a guideline. Here’s what it means:

 

  • No more than 20% of your gross monthly income should go toward auto loan payments
  • Finance the car for no longer than a 4 year loan term
  • Put down a minimum 10% down payment

 

So if your gross monthly income is $5,000, your maximum monthly car payment should be around $1,000. You’ll also want to limit the loan to 4 years and put at least $2,000 down if you’re buying a $20,000 car.

Following this 20/4/10 rule helps ensure your auto loan is affordable within your budget. The shorter loan term and down payment also mean you’ll pay less interest and own the car sooner. While not a hard and fast rule, the 20/4/10 guidelines provide a good starting point for determining a reasonable loan amount.

 

Consider Interest Rates

Interest rates have a big impact on your monthly payments and total loan cost. It’s important to compare rates from different lenders like banks and credit unions. Rates are influenced by factors like your credit score, loan term, down payment amount, and the overall economic environment.

You’ll typically have a choice between a fixed or variable interest rate. With a fixed rate, your interest stays the same over the full loan term. This allows you to lock in a rate if rates are low. A variable rate moves up and down based on an index like the prime rate. This gives you the chance of lower rates but also the risk of higher rates over time.

Run the numbers to see payment differences between a 3% rate from your bank and a 2.5% rate from a credit union. Even a small rate difference can save you hundreds of dollars in interest costs. Aim for the lowest rate possible by comparing options and having a strong credit score.

 

Select the Right Loan Term

When taking out an auto loan, you’ll have the choice between different loan terms, typically ranging from 24 to 84 months. The loan term you choose will have a significant impact on both your monthly payments and total interest costs over the life of the loan.

Shorter loan terms, like 24 to 36 months, mean you’ll have higher monthly payments but pay less interest overall. This is because you’re paying off the loan faster, giving less time for interest to accrue.

Longer loan terms of 72 to 84 months will lower your monthly payment but increase your total interest costs. You’re taking longer to pay off the principal, so more interest builds up over time.

As a rule of thumb, aim for the shortest loan term you can afford based on your budget. This minimizes interest and helps you pay off your auto loan faster. But be sure to run the numbers, as longer terms around 60 months may still give you an affordable payment on pricier vehicles.

Carefully consider the pros and cons of both shorter and longer loan terms. Finding the right balance will help ensure you get an auto loan payment that fits your budget.

 

Watch Out for Added Fees

When shopping for an auto loan, it’s important to pay close attention to any added fees beyond the sticker price of the vehicle. Some common fees to watch out for include:

 

Administration Fees

Many lenders will charge an administration fee, which can range anywhere from $75 to several hundred dollars. This fee is intended to cover the costs of processing paperwork and underwriting the loan.

 

Documentation Fees

Documentation fees are typically charged by the dealership to cover the costs of preparing and filing paperwork. These fees can be from $300 up to $800 in some cases. Always ask the dealer if documentation fees are included so they are not a surprise.

While administration and documentation fees may seem standard, it pays to shop around. Compare loan offers from banks, credit unions and other lenders. Some may waive these fees or offer lower pricing. Avoid getting lured in by a low headline rate, only to get stuck paying hundreds in extra fees.

Reading the fine print is key. Ask lenders to provide a full breakdown of any fees so you can accurately compare total costs. And be ready to negotiate to have unnecessary fees removed. Paying attention to fees will ensure you get the best possible deal on your auto loan.

 

Factor in Additional Expenses

When budgeting for a new car purchase, it’s important to look beyond just the monthly loan payment. Additional ownership costs like insurance, gas and maintenance can add significantly to your overall spending. Here are some of the extra expenses to factor in:

 

Insurance

Car insurance is mandatory in Canada and premiums vary widely depending on your driving history, location, vehicle type and other factors. Get quotes from multiple providers to find the best rate. On average, Canadians pay $1,316 annually for auto insurance.

 

Gas

Fuel efficiency can vary dramatically between vehicles. Carefully research the combined city/highway fuel economy rating for any car you are considering. With gas prices averaging $1.32/litre in Canada, fuel costs for the average driver come to around $2,000 per year.

 

Maintenance and Repairs

As vehicles age, they require regular oil changes, new tires, brake repairs and other maintenance. Set aside $700-1,000 annually for a newer vehicle and up to $3,000 for an older model. Extended warranties can provide peace of mind but add to the overall cost.

Adding up these extra ownership expenses will give you a more complete picture of what you can realistically afford each month for your new vehicle.

 

Use an Auto Loan Calculator

One of the best ways to determine how much you can afford for a car loan is to use an auto loan calculator. These handy online tools allow you to input details like the vehicle price, down payment, interest rate, loan term, trade-in value, fees, and taxes.

The calculator then does the math to estimate what your monthly payments would be based on the numbers you entered. Auto loan calculators provide a quick and easy way to get an idea of payments so you can determine if it fits your budget.

When using an auto loan calculator, play around with the different variables. See how adjusting the down payment, interest rate, or loan term impacts the monthly payment. You may find that increasing your down payment by a few thousand dollars makes the payments significantly more affordable. Or choosing a longer loan term like 72-84 months drops the payment but raises total interest costs over the life of the loan.

Test out multiple scenarios by inputting different combinations of down payments, rates, terms, and vehicle prices. This will give you a clear sense of the maximum monthly payment you can realistically take on. Just be sure to keep your total monthly vehicle expenses within that recommended 10-20% of your take-home pay.

Online auto loan calculators are available from many banks, credit unions, auto manufacturers, and third-party websites. They provide an invaluable simulation tool to find the optimal loan details within your budget as a Canadian buyer.

 

Get Pre-Approved

Getting pre-approved for an auto loan before you start shopping is highly recommended. Pre-approval provides you with a guaranteed maximum loan amount and interest rate, taking the guesswork out of determining affordability. Here’s why getting pre-approved is an important first step:

 

  • Know Your Budget – Pre-approval gives you a firm loan amount you qualify for, making it easy to shop for cars within your budget.
  • Strengthens Negotiating Power – Showing sellers you are a serious buyer with financing already secured can give you leverage to negotiate the best deal.
  • Expedites the Process – With pre-approval, the financing is already handled so you can focus on the purchase and avoid delays.
  • Compare Loan Offers – Getting pre-approved by multiple lenders allows you to compare rates/terms and choose the best auto loan.

 

The pre-approval process is quick and easy. Provide some basic information to a lender about your income, existing debts, and down payment amount. This allows them to evaluate your creditworthiness and extend a pre-approved offer. Be sure to get pre-approved in the same month you plan to purchase your vehicle, as rates and terms are time-sensitive.

Shopping with a pre-approved auto loan in hand allows you to negotiate the car price and terms with confidence, knowing exactly how much vehicle you can afford. Avoid impulsive decisions and headaches by securing financing first.

 

Consider Used vs New

One of the biggest factors impacting how much auto loan you can afford is whether you opt for a used or new vehicle. Used cars tend to be significantly cheaper than brand new models. However, used car interest rates are usually higher – around 5-10% compared to 0-3% for new.

While you may save on the sticker price with a used car, the higher interest rate means you end up paying more over the full loan term. Run the numbers to see if it makes sense to buy used or if you can afford a new car with lower financing.

Buying used also comes with more uncertainties about maintenance costs and reliability down the road. Ultimately both options have pros and cons to weigh based on your budget and needs.

 

Improve Your Credit Score

One of the biggest factors that determines what interest rate you’ll qualify for on an auto loan is your credit score. Lenders view borrowers with higher credit scores as lower risk, so they reward them with lower rates.

The better your credit score, the more likely you’ll be offered the lowest rates from lenders. Ideally you want a score over 700 to get the prime rates. Here’s a rough guide on credit tiers and the rates you can expect:

 

  • 760+ = Excellent credit, prime rates 3-5%
  • 700-759 = Good credit, rates 5-8%
  • 680-699 = Fair credit, rates 8-12%
  • 630-679 = Poor credit, rates 12-18%
  • Below 630 = Bad credit, may not qualify for financing

 

Improving your credit score takes time and diligent financial habits. Here are some tips to boost your score before applying for an auto loan:

 

  • Pay all bills on time – set up automatic payments
  • Pay down credit card balances
  • Limit credit inquiries by only applying for what you need
  • Correct any errors on your credit report
  • Keep credit card balances low, under 30% of limit

 

Give yourself at least 6 months to improve your credit score before shopping for a car loan. The higher your score, the lower your rate and the more affordable your monthly payments will be.

 

Make a Down Payment vs Trade-In

When it comes to affording your next car purchase, you have two main options to lower the amount you need to finance – making a down payment or trading in your current vehicle. There are pros and cons to each approach.

Putting money down upfront in the form of a down payment reduces the loan amount and therefore your monthly payments. The larger your down payment, the less you’ll pay in interest over the loan term as well. Saving up over time is the best way to make a substantial down payment. The downside is that it takes discipline and time to accumulate those savings.

Trading in your current vehicle puts immediate equity towards your new car. The dealer handles valuing your trade-in, accepting it and applying its value towards your purchase. This requires no saving ahead of time. However, trade-in values tend to be lower than the car’s private party value. Dealers need to make a profit reselling your trade-in.

A combination approach is often best – making some down payment from your savings to lower the financed amount, plus trading in your current vehicle to lower it even further. This minimizes the total loan required. Run the numbers to see whether a larger down payment or more valuable trade-in results in the most savings.

The choice often comes down to your specific situation. If you have significant savings and no trade-in, then focus your down payment. If you have equity in your current car but little savings, then trade-in may make more sense. Evaluate your options to make the right down payment vs trade-in decision when determining how much car loan you can afford.

 

Shop Multiple Lenders

When it comes to auto loans, interest rates and terms can vary widely between lenders. That’s why it pays to shop around and compare offers from multiple sources. Here are some tips for getting the best rate on your next auto loan as a Canadian buyer:

 

– Get rate quotes from several banks and credit unions. Financial institutions often have competitive auto loan rates and can offer pre-approval.

Check with online lenders and peer-to-peer lending networks. They tend to offer more flexibility than banks.

– See what’s available from your auto dealership’s financing department. They may be able to beat outside financing.

– Compare all rate quotes side-by-side, along with loan terms, fees and other details. A longer term may have a lower payment but higher overall interest costs.

– Negotiate with lenders to see if they can beat a competitor’s offer. Having multiple quotes gives you leverage.

– Run the numbers to see which lender provides the best overall value based on your down payment, preferred loan length, interest rate and fees.

– Avoid accepting dealer financing without first comparing it against other outside financing options.

 

The bottom line is the more quotes you get, the better chance you have of securing the most competitive auto loan rate and terms. Never take the first offer that comes your way. Cast a wide net and negotiate for the best deal.

 

Conclusion

Finding the car loan you can comfortably afford requires careful consideration of your total monthly vehicle expenses compared to your income. The general guideline is to keep your auto loan payment and related costs below 10-20% of your monthly take-home pay.

By tallying up all your vehicle costs, determining your down payment, selecting the right loan terms, and using auto loan calculators, you can find the ideal loan amount for your budget. Shop multiple lenders to get the best rates. Consider used vehicles to lower your monthly payments. And improve your credit to qualify for better loan terms.

Following the recommendations in this guide will help you choose a car loan payment that fits your overall budget as a Canadian buyer. Enjoy your new vehicle without breaking the bank by sticking within these affordability guidelines.

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Questions About Car Loan Affordability

Financial experts typically recommend spending no more than 15-20% of your monthly take-home pay on car costs, including your loan payment, insurance, gas and maintenance. This ensures your vehicle expenses don’t eat up too large a portion of your income.

Take your monthly net income and multiply it by 0.15 to 0.2, depending on your budget. This is the maximum you should allocate towards total car expenses. Then multiply that figure by 0.85 to determine the maximum monthly loan payment specifically. The remaining 15% covers insurance, gas and maintenance.

 

For example, if your net monthly income is $4,000, you could afford $600-800 total for car costs. Of that, $510-680 could go towards your loan payment.

The average interest rate on new car loans from banks in Canada tends to range between 4-7%, while used car loans generally have higher rates between 7-12% depending on your credit score. Rates from dealerships also tend to be higher.



While 0% down car loans exist, putting down at least 20% is recommended. This results in lower interest charges over the life of the loan. On a $30,000 car purchase for example, try to put at least $6,000 down.



The most common loan terms in Canada are 48, 60, 72 and 84 months (4-7 years). Longer terms of 6-7 years mean lower monthly payments, but you pay significantly more interest over the life of the loan. Terms of 4-5 years are generally recommended to save on interest.



To qualify for the lowest advertised interest rates from lenders, which are usually below 5%, you typically need a credit score of at least 720. Applicants with scores in the 660-719 range can expect higher rates between 5-10% from most lenders.

Yes, getting pre-approved before visiting dealer showrooms gives you negotiating leverage and shows you exact loan terms tailored to your financial situation. Dealerships often offer higher rates, so having financing already secured beforehand is wise.

Typical documents include: valid ID, proof of income (recent pay stubs), proof of address (utility bill), list of assets/liabilities, cost estimate of vehicle you want, and vehicle history report if purchasing used. Having these ready speeds up the application process.

Banks, credit unions and online lenders usually offer the most competitive rates. Banks to consider include TD, Scotiabank, RBC, CIBC, BMO and National Bank. Well-rated credit unions and online lenders also have great rates. Comparison shop to find your best option.

If you have little/no credit history or a low credit score, consider having a co-signer with good credit co-apply with you, as this improves your chances of approval and secures a lower interest rate. Alternatively, save up and buy cheaper with cash.



Financing is usually the better option if you plan to keep the car more than 4 years. Leasing has lower monthly payments but strict mileage limits, wear-and-tear charges upon vehicle return, and no ownership. Financing costs more monthly but you eventually own the asset.

Tips include: shopping around for the best rates, making a large down payment, choosing shorter loan terms (4-5 years), having excellent credit, limiting mileage if leasing, paying more than the minimum payment each month, and prepaying principal whenever possible.

Aside from your loan payment, main costs are gas ($100-300 monthly), maintenance ($100+ monthly average), insurance ($100-350 monthly), licensing/registration fees ($60-150 yearly), winter tires (at least $500-1000 every 3-5 years) and parking costs if applicable in your area.



It’s: Vehicle Price + (Loan Interest x Loan Term) + Insurance Costs + Fuel Costs + Maintenance Costs + Registration/Licensing Fees + Repairs + Winter Tires. Tally all these expenses to determine the true total cost of ownership during your planned length of ownership.

Negotiating strategies that work include: securing financing beforehand at a good rate, researching prices online for leverage, visiting dealerships near month/quarter end to take advantage of sales quotas, avoiding discussing monthly payments early on, negotiating the final price rather than payment, getting quotes from multiple dealers on the exact same model, and being willing to walk away rather than overpay. Test driving the exact car you want also prevents dealer bait-and-switch tactics.



Top sites include: AutoTrader.ca, Autos.ca, Unhaggle.com, CarCostCanada.com, Yahoo Autos Canada, and local dealership websites. Checking recent pricing data on the exact make, model and trim level equips you with excellent negotiation leverage.

Be wary of extra charges like documentation fees ($100-500+), vehicle prep charges ($500-700+), wheel lock fees, nitrogen fill fees ($100+), theft protection fees, extended warranty pressure tactics, and overpriced extras like fabric/paint protection, VIN etching, and rust proofing. These all boost dealer profit and can add $1000+ to your final price.



Insist on seeing the vehicle history report from an authorized provider like Carfax or CarProof before finalizing any purchase. Cross reference the VIN from multiple locations on the car to verify it matches the report and has no title discrepancies. A recent safety certification and mechanical inspection from a trusted shop also helps confirm no major damage or defects are present.

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