Source: Statistics Canada
A car loan allows you to finance the cost of purchasing a car in Canada. Instead of a large, up-front payment, you can pay a monthly fee plus interest. You can use the loan to buy new or even used cars. Additionally, you can use car loans to purchase RVs, commercial vehicles, and more. In most cases, the loan will be secured by your vehicle. If you fail to make payments, the lender can seize your car to pay off your debt.
While car loans are available from various sources, including banks, credit unions, and auto dealerships, it's important to compare interest rates before committing to a loan. The average car loan interest rate in Canada for new loans is 5.23%. However, rates can vary widely depending on the lender, your financial situation, and the type of car. Continue reading to compare auto loan rates and learn how to get the best deal.
Similar to getting a mortgage in Canada, lenders will assess you on various factors. These include your credit score, income, loan characteristics, and the asset in question. In this scenario, the secured asset is your car. This section will dive into these factors to provide a deep understanding of how your car loan rate is calculated.
|Credit Score||A higher credit score will get you lower interest rates.|
|Loan Term||Shorter loan terms result in less interest paid.|
|Type of Car||Lenders prefer car models that are in demand, depreciate slowly, and without known mechanical issues.|
|Income||A lower debt service ratio will decrease your interest rate.|
|Down Payment||Larger down payments will decrease your interest rate.|
Your credit score is one of the most important factors that lenders consider when approving you for a car loan. Your credit score is a number that ranges from 300 to 900 and is used to represent your creditworthiness. Generally, the higher your credit score, the lower your interest rate. This is because people with high credit scores have a track record of making debt payments.
In Canada, a good credit score is considered anything over 760. If you have a low credit score, you may still be able to get approved for a car loan. However, you will likely have to pay a higher interest rate.
|Credit Ranking||Score Range||Interest Rate Range|
|Excellent/ Very Good||725 to 900||3.99% to 7.99%|
|Good||660 to 724||6.50% to 12.99%|
|Fair||560 to 659||13.50% - 22.99%|
|Poor||300 to 559||Likely won’t receive a loan|
Your term length is the loan characteristic that affects your interest rate the most. A longer loan will result in a higher interest rate because the lender is taking on more risk. This is because you are more likely to default on a longer loan. For example, it's easier to miss a few monthly payments on an 84-month loan than on a 36-month loan.
A longer loan term will also result in a higher interest rate. This is because the lender is exposed to more risk if you default on your loan.
|Loan Term||Interest Rate Range|
|Less than 78 Months (6.5 Years)||4.5% to 8%|
|79 to 83 Months (6.5 - 7 Years)||5.5% to 9%|
|Over 84 Months (7 Years)||6% to 9.5%|
Lenders want to ensure they can quickly sell your car to pay off your loan if you default. As a result, lenders are concerned with the following information about your vehicle:
A luxury car will have a higher interest rate because they are riskier to lenders. There are not many buyers, they depreciate quickly, and are very costly to repair. For these reasons, many lenders have a limit of $75,000 for auto loans. Additionally, cars older than seven will have a higher interest rate. You will receive the best interest rates for newer vehicles that are in high demand, retain value, and are reliable.
Lenders calculate the percentage of your income paying off debt obligations. For example, you may have student loans, a mortgage, and more. A higher income will only increase your chances of getting approved for an auto loan if you don't have ballooning outstanding debts.
This ratio is known as your debt service ratio. A lower ratio is better because less of your income is stuck paying off debts. As a result, you are less likely to default on your auto loan.
The best way to reduce your debt service ratio is to increase your income or reduce your debts. A quick way to decrease debt payments is using a debt consolidation loan to achieve a lower interest rate.
"GAP" stands for "guaranteed asset protection." GAP insurance is an optional product that can be added to your car loan. It covers the difference between the amount you owe on your loan and your car's worth if it's stolen or totalled in an accident.
A higher down payment means you are less risk to your lender. As a result, you should receive a lower interest rate. Lenders require a down payment in case they need to seize your car and sell it. The down payment provides them with a safety cushion in case they need to sell the car to pay off your debts.
For example, imagine you received a $7,000 loan to buy a $10,000 car. As a result, your down payment would be $3,000. If you immediately defaulted on your loan, the lender can claim the vehicle and sell it for $10,000. This would recover their $7,000 loan, and you would receive the surplus, less legal and administrative fees.
However, if your down payment was only $500, there would be more risk to the lender. They would scramble to sell your car at market prices and may not recover their loan. As you can see, a higher down payment provides less risk to your lender, which should give you a better interest rate. If you have a trade-in vehicle, this can be used as part of your down payment. Make sure to research your vehicle model to ensure you are getting a fair price for your trade-in.
The best way to ensure you get the best interest rate on your car loan is by having a solid application. This includes:
Navigating auto loans can be overwhelming. Similar to understanding mortgages in Canada, there are many complex words. Additionally, not understanding something could end up costing you thousands in interest charges. This section will demystify auto loans to help you best compare them.
The majority of auto loans in Canada are variable rate. This means your interest rate will change with the prime lending rate. When the Bank of Canada increases or decreases its overnight lending rate, your car loan interest rate will follow suit.
For example, if you have a variable car loan with an interest rate of prime plus 2%, and the prime rate is 3%, your interest rate would be 5%. However, if the prime rate increased to 4%, your interest rate would increase to 6%. For a full explanation of interest rates, find the section below titled "How Interest Rates Impact Your Car Loan."
The term length is the amount of time you have to repay your car loan. In Canada, most auto loans have terms between 4 and 7 years. The longer the period, the lower your monthly payments will be. However, you will pay more in interest charges over time.
It's generally advised to keep shorter term lengths because your car depreciates faster than you can pay off the loan. At the end of a long term, many people find their car less valuable than their loan balance. They are "underwater" on their loan. Short term lengths will prevent this and save you on higher interest rates.
Most lenders have a maximum and minimum amount they are willing to lend you. For example, a lender may only finance a car that costs between $10,000 and $75,000.
Your down payment is the lump sum you pay upfront to lower your loan amount. The larger your down payment, the lower your loan amount, monthly payments, and interest charges will be. In Canada, most lenders require at least 10% of the car's total value as a down payment.
Trading in your old car will act as a down payment and lower the amount you need to finance. Larger down payments lower your monthly payments and save you on interest charges. Ensure you research the actual value of your car to determine if the dealer is providing a good deal. Otherwise, you could save money by selling your old car on a classified site and using the proceeds as a down payment for your new vehicle.
You can usually tailor your car loan payments to suit your budget better. Some lenders allow you to make bi-weekly payments instead of monthly payments. Bi-weekly payments work by splitting your monthly payment into two smaller payments. You make one payment every two weeks instead of one payment per month.
Making bi-weekly payments will help you repay your loan faster and save on interest charges. It's a great way to stay on top of your car loan and make extra payments when you can afford it.
Most lenders in Canada allow you to make additional payments or pay off your loan early without any penalties. This is called "pre-payment privileges." Pre-payment privileges are great because they allow you to save on interest charges by paying off your loan faster.
However, some lenders will charge a "pre-payment penalty" if you pay off your loan early. These penalties can be up to 3% of your original loan amount. Make sure you know whether or not your lender charges pre-payment penalties before signing your loan agreement.
The car you want to finance will usually need to meet specific criteria the lender sets. For example, most lenders will only finance cars less than ten years old and have less than 160,000 kilometres on them.
Lenders put these restrictions in place because they want to minimize their risk. They are more likely to approve a loan for a newer car because it will have a lower chance of breaking down and will hold its value better over time.
Car dealerships provide fast and easy-to-qualify loans. While a bank or credit union may have more lending criteria, they often have a lower interest rate than dealerships. However, in some cases, dealerships will have promotional rates such as 0% APR.
While this is a great deal, ask about the interest rate after the promotion ends. You may sometimes be stuck with a higher interest rate for the remainder of the term. Additionally, dealers may try to pressure you into more products, such as extended warranties. Be aware when negotiating with a dealer. Do your research and you may have an even better interest rate.
If you are not a homeowner, your best option is a car loan from a dealer or traditional lender. However, homeowners can access better interest rates by leveraging their home equity. You receive lower rates because you secure the loan with your home instead of a car.
If you fail to make payments, the lender can seize your home instead of a car. However, financially dependable homeowners will save a considerable sum on the lower interest rate. Below are some of the best options for homeowners to buy a car.
You can think of a HELOC as a credit card tied to your home. You will not need to make payments if you don't use the money. However, if you use the line of credit, you must make monthly payments. The interest rate is variable based on the prime rate plus a margin.
A HELOC can be used for anything, including a car purchase. As a result, it provides considerable flexibility in how you use the money. Additionally, the interest rate will be lower than a car loan, and you won't need an additional down payment.
A cash-out refinance resets your mortgage and provides you with affordable access to debt. It can be used to pay for anything, including a car purchase. The interest rate will be lower than a HELOC and auto loan, but there is less flexibility.
Unlike a HELOC, you will need to make interest payments immediately. Additionally, there is a more difficult qualification process. To avoid mortgage-breaking fees, it's recommended to proceed with a cash-out refinance when your mortgage term ends. Unless you want to buy a car at the end of your term (usually every five years), consider another option.
A reverse mortgage allows you to withdraw money from your home as a HELOC or cash-out refinance would. However, you will only need to pay the debt when you move or sell the house. This is an exciting option for homeowners over 55.
You can receive the money as a lump sum or in recurring payments of your desired frequency. With a reverse mortgage, you can use the funds to purchase a car without a down payment. Additionally, if your home value appreciates more than your reverse mortgage interest rate, the loan has effectively paid itself off.
If your car loan is variable, it will change with the Bank of Canada Rate throughout your term. This means an increase in the overnight rate will increase your loan rate and your monthly payment by the same amount.
Usually, your lender will have a fixed profit margin on top of their prime rate. For example, RBC adds a 2.9% to 11.9% premium on top of their prime rate. The premium you receive is dependent on your creditworthiness. For example, someone with a high credit score, low debt service ratio, and reliable car model would receive a premium closer to 2.9%. Whereas someone who is not creditworthy is seen as riskier, so they must pay a higher premium.
Your variable interest rate will match the prime rate plus your premium. An increase in the prime rate will also increase your payments. A decreasing rate will lower your monthly payments. Your payments won't change throughout your term if you have a fixed rate.
The annual percentage rate (APR) is always more important than your interest rate. APR will always indicate the actual cost of borrowing. The interest rate does not reflect additional fees charged by a lender. Sometimes, lenders entice you with low interest rates and high finalization fees.