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Pros and Cons of Financing a Car in Canada

Pros and Cons of Financing a Car in Canada

With new vehicle prices reaching record highs in Canada, financing is becoming more popular. In 2021, 86% of new car purchases and 53% of used cars were financed rather than bought with cash.


While financing spreads costs over time, it also comes with drawbacks. This comprehensive guide examines the pros and cons so you can determine if borrowing for your next car purchase aligns with your budget.

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Lower Upfront Costs

One of the biggest benefits of financing a car rather than paying cash is that it allows you to spread out the cost over time through a monthly payment plan. This greatly reduces the amount of money you need to put down upfront. For many buyers, coming up with $20,000+ in cash is simply not feasible, even for a used car purchase. Financing opens doors to buying a much nicer, more reliable vehicle that better suits your needs.

With a car loan, you may only need to put down a deposit of 10-20% of the purchase price. The rest gets covered by the amount financed through the lender. This lower entry cost makes it possible to get a late model car with lower mileage and modern tech features. New cars often come with full warranties as well. Without financing, you may be limited to older used cars that require more maintenance and repairs.

Additionally, by putting less money down upfront, you retain more cash savings as a financial cushion. This offers more flexibility and options should an emergency or unexpected expense come up. You avoid fully depleting your bank account on a vehicle purchase.

The bottom line is that financing opens the door to vehicles that better match your lifestyle and transportation needs. While paying cash may seem ideal, you would likely have to compromise on the type of car you can realistically afford. Financing helps bridge the gap between the car you want and the cash you have on hand today.

 

Fixed Monthly Payments

One of the biggest advantages of financing your car purchase is the ability to spread out the cost over time through fixed monthly payments. When you take out an auto loan, the lender will determine the size of your monthly payment based on factors like the loan amount, interest rate, and length of the term.

Having a set monthly car payment makes it easy to budget for this expense. You’ll know exactly what to expect each month for your car payment, allowing you to plan your other spending and savings goals around this fixed cost. This predictability and consistency is valuable for managing personal finances.

Auto lenders typically offer loan terms of 24 to 84 months. Opting for a longer term means lower monthly payments, while a shorter term increases the monthly amount due but saves on interest paid over time. Evaluate your budget to find the monthly car payment you can comfortably afford each month.

The fixed payment schedule also helps establish a track record of on-time payments with your lender. Making these consistent monthly payments demonstrates financial responsibility and will help build your credit history.

 

Build Your Credit

One of the biggest advantages of financing your car purchase is the ability to build your credit history. When you make all your monthly payments on time, it shows lenders that you are reliable and responsible with borrowed money. This helps establish a positive track record that will make it easier to get approved for other loans and credit products in the future.

Your payment history is the biggest factor that determines your credit score. According to credit bureau TransUnion, it accounts for 35% of your score. So by never missing a payment or making one late, you can raise your credit score over time. This is valuable because the higher your score, the lower interest rate lenders will offer you. Good credit also opens the door to more options when you need to borrow money again.

If you have little or no credit history, financing a car is one of the fastest ways to start demonstrating you handle credit well. Within just a year or two of on-time payments, you can build up your score enough to qualify for top-tier interest rates. This makes financing worth it, even if you could afford to pay cash upfront. The long-term credit benefits are significant.

 

Special Lender Incentives

One potential perk of financing your next vehicle is gaining access to special incentives offered by lenders and dealerships. These can make the loan terms more attractive and help offset some of the extra costs of borrowing.

Many banks and credit unions that provide auto loans will run periodic promotions to entice new borrowers. For example, you may be able to get a discounted interest rate by meeting certain conditions or qualifications. Some lenders also offer cash rewards of a few hundred dollars when you open a new auto loan with them.

Dealerships also have incentives from manufacturers to encourage financing through their preferred lenders. They receive kickbacks for connecting customers with certain banks and captive finance companies. As a result, the dealership is often able to discount the purchase price, throw in extras like extended warranties, or offer very low interest rates when you finance on-site.

It’s a good idea to check for any current promotions before you start shopping for a vehicle. That inside knowledge can help you negotiate a better overall deal. Just be sure to still compare interest rates and do the math on the total cost of borrowing. Sometimes an incentive offer has more sizzle than real savings.

 

Convenience of Dealership Financing

One of the biggest advantages of opting for dealership financing is that you can handle everything in one place. Rather than having to shop around for loan rates at banks and credit unions separately, the dealership acts as a one-stop shop. This streamlines the buying process significantly.

When you finance at the dealership, you can walk in, pick out the car you want, negotiate the pricing, apply for financing, get approved, and drive off the lot in your new vehicle all in the same day. The dealership handles submitting your loan application to lenders and gets you a financing decision quickly.

This saves you the hassle of having to go through pre-approval at a bank, then negotiating with the dealer, then having the dealer re-submit your application to their lenders. With dealership financing, they often have relationships with lenders to expedite approvals.

You also avoid the inconvenience of having to go back and forth between the dealer and your bank for paperwork and signatures. The dealer handles everything on-site, making the whole financing process seamless.

 

Expensive Interest Charges

One of the biggest drawbacks of financing a car is the interest expenses that accumulate over the loan term. Auto loans typically last 3-5 years for new vehicles and 2-4 years for used. Even at competitive interest rates, the total interest paid can really add up over that time.

For example, on a $30,000 loan at 4% interest over 5 years, you would pay about $2,300 in total interest charges. Bump the rate up to 8% on a used car loan, and you may pay $5,000 or more in interest. The longer the loan term, the more interest you pay overall.

It’s important to understand that interest is paid over the life of the loan, in addition to the original principal amount borrowed. So your monthly payments will be higher than if you bought the car with cash upfront and avoided financing charges.

Many buyers are attracted to long loan terms of 6-8 years because it provides lower monthly payments. But this dramatically increases the interest paid over time. A shorter 3-4 year loan costs much less in the long run.

When evaluating auto financing, look closely at both the interest rate and length of the loan to determine your true cost of borrowing. It’s not just the monthly payment – total interest charges should be factored in as well.

 

Risk of Being Upside Down

One of the biggest risks of financing a car is owing more on the loan than the vehicle is actually worth. This situation is known as being “upside down” or “underwater” on your auto loan.

When you finance a new car, it begins to depreciate rapidly from the moment you drive it off the lot. However, you continue owing the full loan amount regardless of the car’s decreasing value. After just one year, your car could be worth 20-30% less than what you paid for it.

But if you have a 5-6 year loan term, you may still owe 80% or more of the original purchase price several years into the loan. This leaves you upside down – the car’s trade-in or resale value is less than the remaining loan balance.

Being upside down makes it very difficult to get out of your loan. If you want to sell or trade in your car, you’ll have to come up with extra money to pay down the loan first. Otherwise, the negative equity gets rolled into your next auto loan, leaving you deeper in debt.

To avoid this situation, opt for shorter loan terms of 3 years or less. And consider used vehicles that don’t depreciate as severely in the first few years. Putting more money down upfront also reduces the risk of ending up underwater on the loan.

 

Stuck with Payments

One of the biggest downsides of financing a car is that you’ll be committed to making monthly payments, often for many years. When you take out a typical 5-year car loan, you’ll be paying it off for the next 60 months without fail. That’s a long-term commitment that reduces flexibility in your monthly budget.

If you lose your job or experience a drop in income, those auto loan payments will still be due every month. Miss or default on the payments, and you risk damaging your credit along with facing repossession of the vehicle. It can be stressful knowing your car can be taken away if you can’t afford the monthly bills.

Even if you want to pay off the loan early, you’ll face prepayment penalties and fees. Plus, most car loans have early payout restrictions preventing you from paying it off sooner than a set timeframe, often 12-18 months into the loan.

With financing, you’re locked into monthly payments for years. That reduces budget flexibility compared to buying a cheaper used car with cash, where you aren’t committed to years of installments.

 

Fees and Penalties

One downside of financing a car is that you can face expensive fees and penalties if you miss or are late on your monthly payments. Auto lenders will charge late fees, typically around $30-50 if your payment is more than 15 days past due. If you miss multiple payments in a row, the late fees can really add up.

In addition to late fees, the lender may also hit you with a returned payment or non-sufficient funds (NSF) fee of $25-50 if your payment bounces. Some lenders will allow a short grace period for bounced payments, but you’ll still likely face a fee.

If you fall too far behind on payments, the lender can repossess the vehicle and charge you repossession fees on top of what you already owe. Repossession fees typically range from $300 to $500. The lender will also charge you for any costs incurred while retrieving the vehicle, like towing fees.

Before financing, carefully review the lender’s fee schedule so you understand the penalties for late or missed payments. Factor these potential fees into your budget to ensure you can comfortably afford the monthly payments.

 

Difficulty Getting Approved

One of the biggest downsides of financing a car is that borrowers with poor credit often have difficulty getting approved. Lenders view these applicants as high-risk, so they will either deny the loan application or offer very unfavorable terms.

Those with credit scores below 600 will likely struggle to qualify for financing from prime lenders like banks and credit unions. Subprime lenders that specialize in bad credit loans may approve borrowers with scores as low as 500, but the interest rates are much higher, often over 20%.

If you have a recent bankruptcy, foreclosure, or history of late payments, it becomes even harder to get approved. Lenders will want to see that you’ve had time to recover and rebuild your credit first.

Without access to financing, poor credit consumers may feel forced to buy an unreliable used car with cash. This creates a frustrating cycle where they can’t improve their credit through an auto loan yet also can’t qualify to finance a better vehicle.

Those able to get approved despite bad credit end up paying significantly more for the same vehicle due to higher interest charges. It makes the already expensive process of financing even more detrimental to their finances.

 

How Interest Rates Impact the Cost of Borrowing

When financing a vehicle, the interest rate can have a significant impact on your total borrowing costs. Generally speaking, the lower the interest rate, the less interest you’ll pay over the full loan term.

It’s important to compare interest rates offered by different lenders like banks, credit unions, and the dealership financing arm. Rates can vary quite a bit between lenders. Also pay attention to whether you’re being offered a prime lending rate, which is reserved for borrowers with excellent credit, or a higher subprime rate.

To get a sense of how the interest rate affects overall costs, you can use an auto loan calculator. Input the purchase price, down payment, loan term, and interest rate to see the monthly payment amount and total interest charges. Play around with different loan terms and rates to find the most affordable option.

Generally, shorter loan terms of 3-4 years have lower interest rates. This helps keep your total borrowing costs down. Even though the monthly payment is higher, you’ll pay less interest over the full loan period. Opting for the shortest term you can reasonably afford based on your budget is usually the best way to save on interest.

 

New vs. Used Car Financing Considerations

When deciding whether to finance a new or used vehicle, it’s important to weigh the unique pros and cons of each option:

 

New Car Financing

Pros:

 

  • Latest safety features and technology
  • Full warranty coverage
  • No previous wear and tear
  • Lower maintenance costs initially
  • Greater selection of colors/options

 

Cons:

 

  • Faster depreciation when new
  • Higher sticker price
  • Higher interest rates often
  • Insurance costs may be higher

 

Used Car Financing

Pros:

 

  • Lower purchase price
  • Slower depreciation
  • Certified pre-owned options still have warranty
  • Wider selection of brands/models

 

Cons:

 

  • No new car warranty
  • Higher mileage and potential wear
  • Maintenance costs may be higher
  • Less selection for colors/options

 

By weighing these key differences, you can determine if it makes more financial sense for your situation to finance a new or used vehicle.

 

Tips for Getting the Best Car Loan Terms in Canada

If you decide that financing is the right choice for your situation, make sure you go into the process informed and prepared to get the best possible loan terms. Here are some tips for Canadians looking to secure the most affordable auto financing:

Check your credit report for any errors – Mistakes on your credit report can negatively impact your score and the loan terms you qualify for. Review all the details and dispute any inaccuracies with the credit bureaus.

Know your budget and ideal payment – Calculate how much you can realistically afford to pay each month for a car loan. This will help you shop for vehicles and loans that align with your budget.

Get pre-approved before visiting dealers – Being pre-approved gives you negotiating leverage and shows the dealer you’re a serious buyer. Compare rates from banks, credit unions, and other lenders.

Negotiate the purchase price first – Don’t discuss financing until you’ve agreed on the vehicle price. This gives you the strongest bargaining position.

Secure quotes from multiple lenders – Compare loan terms from several sources. Local banks and credit unions may offer the lowest rates.

 

Making the Decision: Is Financing Worth It for You?

Financing can be a smart option or lead to financial hardship depending on your situation. Use this guide to weigh the pros and cons and determine if borrowing for your next car aligns with your budget and goals.

Review the potential benefits like lower upfront costs, fixed monthly payments, and special incentives that make financing attractive for many buyers.

Then carefully consider the downsides, including expensive interest charges, the risk of being upside down on your loan, and getting stuck with payments for many years. Run the numbers to see how interest rates impact your total borrowing costs.

Look at your specific circumstances—is your credit score strong enough to get approved for the best rates? Do you need a reliable used car or can you maintain an older vehicle? How long do you plan to keep this car before upgrading again?

By weighing all these factors against your financial situation and goals, you can make an informed decision if taking out a car loan is the right move or if you’re better off buying with cash upfront.

Use this comprehensive guide to financing pros and cons as a resource. And approach the process thoughtfully, so you can end up with affordable payments that fit your budget on a car you’ll enjoy driving for years to come.

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Questions About Pros & Cons of Financing a Car

Financing a car in Canada has several pros and cons to consider. The main pros are that financing allows you to purchase a more expensive vehicle than you could pay for upfront, spreads out payments over time, and helps build your credit score if payments are made on time. The cons are that you’ll end up paying more for the vehicle with interest charges, financing limits your future budget flexibility with a fixed monthly payment, and missing payments can damage your credit.

 

New auto loan interest rates in Canada currently range from 0% for certain promotions up to around 8% from banks and dealerships. Rates depend on factors like your credit score, the loan term, down payment amount, and the lender. The lowest rates tend to be around 0-3% for buyers with excellent credit on shorter term loans. Used car loans have higher interest rates ranging from 5-15% on average.

 

To qualify for the lowest auto financing rates in Canada, you typically need a credit score of 720 or higher. Scores between 660-719 qualify for good rates, but not necessarily the rock bottom advertised promotional rates. Anything under 660 makes getting approved more challenging and results in higher interest rates. Improving your credit score can result in thousands of dollars in interest savings when financing a car.

 

The top options for financing a car in Canada are through a dealership, bank, credit union, or third-party lender like a finance company. Dealerships facilitate loans through partnerships with banks and financing companies. Banks and credit unions provide direct auto loans. And other lenders cater specifically to auto loans. Going through your own bank sometimes results in better rates thanks to existing relationships.

Common car loan terms available from Canadian lenders range from 12 months up to 84 months (7 years). 36 and 48-month loans used to be most typical, but longer 6-7 year terms have become popular to lower monthly payments. Keep in mind longer loans mean paying more total interest so shorter terms save money if affordable. 12-24 month terms have the lowest rates but highest payments.

Putting down at least 20% is recommended when financing a car in Canada to get the best rates and avoid being underwater on the loan. Most lenders now require a minimum of 5-10% down. Bigger down payments also lower your monthly obligations which helps affordability and credit score improvement. $0 down promotions do exist but lead to higher interest costs and loan-to-value ratios.

Common fees charged for auto loans in Canada include an origination fee (up to $500+), documentation fee ($50-$150), lien registration fee (around $20-60 depending on the province), and PPSA fee ($10-$50). There may also be loan prepayment penalties if you pay off the financing early. Ask lenders to explain all fees to avoid surprises.

Dealerships are convenient when bundled with the car purchase but sometimes charge higher rates. Banks and credit unions should be shopped to compare rates, though they may take more effort. Also try other lenders like finance companies. Whoever offers you the lowest interest rate for your situation is the best option.

Leasing pros include lower monthly payments, always having a newer vehicle, and potential tax benefits for businesses. Cons are mileage limits, wear and tear fees when returning the car, no equity, and lease-end costs. Financing pros are building eventual ownership equity and no mileage limits. Cons include higher monthly payments than leasing and being stuck with negative equity if upside down on the loan.

Most major car brands offer special financing promotions in Canada from time to time through their captive finance arms like 0% interest for 36 months, cash allowances for financing with the automaker’s bank, and deferred payments. Offers vary by brand, model, and time of year and help drive sales events. But the fine print should be read carefully.

 

Tips for getting the lowest car loan rate in Canada include maintaining an excellent credit score over 720, researching current promotional interest rates, comparing quotes from multiple lenders, limiting your loan term length, making a 20%+ down payment, and being flexible on vehicle makes/models if trying to combine 0% financing offers.

 

Besides regular car loans, other financing options exist like 0% retailer credit cards, personal loans or lines of credit from a bank, using home equity, borrowing from retirement plans like your RRSP, or family loans. But traditional auto financing tends to offer the best rates assuming you have good credit.

 

Being pre-approved makes car shopping easier and saves time at the dealership. You know what rates/terms you qualify for ahead of time rather than waiting for the dealer’s finance office. It gives you strong negotiating leverage on the car price itself if the dealer knows you already have financing locked in.

Tips for improving your chances of auto loan approval and securing the best interest rate include maintaining good credit history, limiting total debt obligations, keeping your job and income stable, minimizing loan term length, making a larger down payment if possible, having a co-signer with better credit, and comparing multiple lender quotes.

 

As a general rule, your car purchase price including taxes should not exceed 50% of your gross annual income. And your total monthly vehicle costs including the loan payment, insurance, gas and maintenance should be below 20% of your monthly gross income to remain affordable based on Canadian recommendations.

 

Shorter term loans have higher monthly payments but save substantially on interest costs. Longer term loans are easier to afford each month but add thousands in interest over the life of the loan. Stretching beyond 6 years also increases the risk of negative equity and going upside down on the loan as the car depreciates.

Making a down payment of 10-20% or more is recommended to get the best rates and keep monthly payments affordable. However, some people prefer making a minimum payment to conserve cash or invest their money elsewhere hoping for higher returns. Run the numbers for your situation but additional down payments usually pay off.

Older used vehicles over 8-10 years, high mileage over 150k km, and poor condition make getting approved and decent rates very difficult. The newer, lower mileage and better shape your car is, the more favorable the loan terms. Private sales also get less financing flexibility than newer dealer vehicles.

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