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What a car loan can do to your credit and borrowing capacity, and how interest and add-ons really do add up.
The thrill of driving a new car off a dealer’s lot is appealing, but experts warn not to let the new car smell go to your head when it comes to borrowing money to make it happen.
Mark Kalinowski, a credit counsellor and financial educator at the Credit Counselling Society, says you need to know what you can afford when it comes to a car loan. “If you can’t pay for it and they repossess it, well, now your credit’s ruined for a long time,” he said. You can only afford so much credit based on your income level, so if you take on a car loan, that will eat away at other borrowing capacity such as a mortgage, Kalinowski said.
When shopping for a car, the numbers can come fast and furious and they can add up quickly. It’s important to keep the total cost of the vehicle in mind, Kalinowski said, not just the monthly or biweekly payment you will have to make. “One of the big things you see in dealerships is they don’t sell you the price of the car, they sell you the payments,” he said.
Additions like an extended warranty and undercoating may only add a few dollars a month to your payment, he says, but they can pile up to add significant costs to the overall price. “They’re going to roll [it] into the financing, so now you’re gonna pay interest on it as well,” he said.
Gone are the days of easy credit and dealership offerings of 0% financing for new cars and trucks, so it’s important to shop around to ensure you’re getting the best deal you can on your loan, said Natasha Macmillan, director of everyday banking at Ratehub.ca. (Both MoneySense and Ratehub are owned by Ratehub Inc.)
“It can save hundreds to thousands of dollars or more for a car or anything like that,” she said.
Kalinowski said borrowing from your bank instead of using the dealership financing may also give you some additional bargaining power.
Macmillan added that a better credit score typically means a better interest rate, so if you delay your purchase to give yourself time to improve your rating, it could save you money.
The term of the loan is also key. A longer term will mean lower monthly payments, but will raise the overall cost of the vehicle because you will be paying interest on the amount you borrow for longer.
Kalinowski said his father told him not to borrow money to buy a new car for a longer term than the vehicle’s warranty.
The value of a new car also drops once you leave the dealership, something that could leave you owing more on your new ride than it is worth. To help limit that gap, you can make a down payment.
A larger down payment will also help reduce the interest you will have to pay, said Macmillan. “Typically, it’s recommended that you look for a down payment anywhere between 10% to 20% of the car’s purchase,” she said.
Kalinowski added that saving the money for a down payment can also have an additional benefit. “I think if you can save the money to make the down payment, you are demonstrating that you can afford the car moving forward,” he said.
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