When you’re gearing up to buy a new or used car, if you can’t pay for the whole thing in cash, chances are you’ll need to apply for some kind of financing or loan.
According to a 2018 CBC report, more than 50 per cent of all new car loans in Canada are financed for 84 months. This stat points to an increasing number of people jumping into longer-term loans, sometimes purchasing vehicles they can’t really afford.
Here’s where your credit score comes in: lenders will look at your credit, among other things, when deciding if they will approve you for a car loan, and if so, what your interest rate and credit limit will be.
Understanding exactly what credit is, how it’s calculated and how good or bad credit can impact your power as a consumer can be confusing for those who are new to the financial ball game, but it’s certainly something you should be familiar with if you’re planning on applying for a car loan in Canada.
To break the credit score ice, keep reading to find out what a credit score is, why it’s important and what credit score you should be shooting for to get a car loan in Canada.
What is a credit score?
A credit score is a three-digit number that signifies your reliability as a credit user and how likely you are to repay your debts on time. In Canada, credit scores typically range from 300 on the low end (which either means you have bad credit or are just beginning to build credit) to 900 on the top end (which is considered excellent credit). Your credit score is based on things like how many accounts you have in good standing, how often you make payments on your credit card or line of credit and how much debt you carry each month. With car loans specifically, lenders will also evaluate if you’re prone to making late payments, have had any repossessions, settled, or declared bankruptcy on an auto loan.
A higher credit score means you’ve demonstrated that you are a responsible credit user, which will make lenders feel more comfortable giving you a loan.
There are many different scoring models which pull information from different parts of your financial profile, such as your income. There are two credit reporting agencies in Canada—Equifax and TransUnion—and you can order your credit report from them at least once a year for free.
In general, here’s how credit score categories break down according to Equifax:
- 300-579: Poor
- 580-669: Fair
- 670-739: Good
- 740-799: Very good
- 800-900: Excellent
The average Canadian has a credit score around 650, which is considered good, but don’t panic if yours falls below that. There are still options for you to get a car loan, which we will discuss a little further down.
Why is a credit score important?
As you’ve likely discovered, credit scores play a big role when lenders, insurers, landlords and any number of other companies are assessing your stability when it comes to creditworthiness.
A car is one of the biggest assets a person can acquire, so it’s important to understand how your credit score will help or hinder your potential loan approval and how it will impact the interest rate and credit limit you are offered. Generally, the lower your credit score, the higher your interest rate because in the eyes of the lender, you are more of a credit risk.
Auto-specific credit score
When applying for a car loan specifically, lenders will likely use an auto-specific credit score, which looks at your credit history when it comes to your dealings with cars. To refresh your memory, that would include any missed or late payments on previous car loans, repossessions, defaulting on the loan or if you have declared bankruptcy on an auto loan.
You can bring in a copy of your credit score to compare to the auto-specific one your lender may have. If your overall credit score is better than your auto-specific one, you may be able to lower your interest rates, which could save you a bundle over time.
What type of credit is a car loan?
A car loan is what is known as installment credit, meaning your loan is for a fixed amount of money and there is a specific and agreed-upon bi-weekly or monthly repayment schedule. Other forms of installment credit include mortgages, personal loans and student loans.
Installment loans can have a payment period of just a few months all way up to several years, depending on the amount borrowed. An auto loan is considered to be a “secure” type of installment credit because the finance company has the option of repossessing the car if you default on payments.
What credit score do I need for a car loan?
According to bankrate.com, the average score needed to secure a car loan is 719 or higher for a new car, and 655 for a used car. Super prime borrowers who have a credit score of 781 or higher will receive an average of 4.19 per cent financing on a new car.
While it’s still possible to get a car loan with bad credit, your interest rates will quickly climb, as shown in the chart below.
|Credit Score Range||New Car Loan||Used Car Loan|
|Super Prime: 781 to 850||4.19%||4.69%|
|Prime: 661 to 780||5.01%||6.38%|
|Nonprime: 601 to 660||7.91%||10.91%|
|Subprime: 501 to 600||12.17%||16.78%|
|Deep Subprime: 300 to 500||14.88%||19.62%|
Interest rates on new cars vs. used cars
Generally speaking, interest rates are lower on new cars than they are on used cars simply because lenders view a purchase of a new car as less of a risk. This is because new cars are less likely to break down and it’s easier to predict how much a new car will depreciate over time and what the resale value will be. Hint: as soon as you drive a new car off the lot, the value of that car depreciates by about 10 per cent.
As you can see in the chart above, for deep subprime borrowers, the difference in average interest rates between a new and used car is more than five per cent, which, when thinking about a long-term loan stretched out over 60, 72 or 84 months, equates to a huge amount of money.
That isn’t to say that buying new is definitively the better option for those who are struggling with bad credit. Remember: the base cost of a new car can be substantially higher than that of a used car, so paying higher interest on a lower principal amount will likely still end up being a lower monthly payment than paying lower interest rates on the larger purchase price of a new vehicle.
How do I improve my credit score to get a car loan?
If you’re concerned that your credit score isn’t high enough to score an auto loan, there are a few things you can do to improve your credit rating in the months (or years) prior to applying for car financing.
The first thing you can do is correct any errors in your credit file. They do happen (actually they happen relatively often) and can drastically impact your credit score. Errors can be anything from a clerical error to loan or credit-card payments being credited to the wrong account to name mix-ups to anything else you can possibly think of.
If you notice an error in your credit report, you should contact the credit bureau immediately, as well as the financial institution that provided the bureau with that information. It’s super easy to dispute errors—just log on to the bureau’s website and fill out an online form.
Lower your balances below 50 percent
The next thing you can do is work hard to lower the balances on your current credit cards and loan amounts. If your balances are above 50 per cent of your available limit, your credit score will take a hit, so create a payment plan to reduce the debt as quickly as you can.
But the best thing you can do, and it may seem scary for someone who hasn’t had the best luck with credit in the past, is to continually use credit and repay that credit on time, every time. You don’t have to make large purchases—even paying for your weekly groceries or gas on credit and paying it off right away will help increase your credit score. You can set up auto-payments through your bank to help make sure you don’t forget your payments each month.
Can I still get a car loan with a bad credit score?
The short answer here is yes! It will take a bit more leg work on your end and you’ll end up with an interest rate on the higher end of the scale, but you should be able to secure a car loan even with bad credit.
While a credit score certainly plays a large part in the approval process, it’s not the only thing lenders look at. If you have stable employment and income and a low debt-to-income ratio, this will work in your favour despite bad credit.
The key is to enter the loan-approval process as prepared as you could possibly be. Have all your paperwork in order, know your financial stats and credit score, shop around to find a lender that makes the most sense for you (be it your bank, a credit union or a dealership) or find a cosigner who is willing to enter into the loan with you.
And, of course, using the tips above to improve your credit score will also aid you in proving your reliability as a borrower.
There are also a few dealerships with payment plans specifically for those who are entering into the car-buying process with shaky credit. See RightRide’s blog post for more information on getting a car loan with bad credit.
There’s a lot of information to take in about credit scores, but here are the basics. A credit score is a numerical representation of your history as a credit user. The higher your credit score, the more responsible you are in the eyes of lenders. If your score is on the lower end, you are deemed a risky person to give credit to.
In Canada, the average consumer looking to get a car loan has a credit score of around 719 (which is very good) or higher. Your credit score also impacts your interest rate on a car loan. People with lower credit scores often get hit with higher interest rates, especially when buying used vehicles as opposed to new.
Lenders will often look at auto-specific credit scores, which address your history using car loans including any missed or late payments, repossessions, defaults or bankruptcy on an auto loan. This credit score may be different than your overall score, so it doesn’t hurt to bring a copy of your general credit score with you to any loan discussions with your lender. If your overall credit score is better than your auto-specific one, the lender may reduce your interest rate which could mean big cash savings over the course of your loan repayment period.
Your credit score does count for a lot when it comes to car loans, so it’s important to keep tabs on your credit report and credit problems if you are planning on making a big purchase like a car. A good credit score can ultimately save you a lot of money when it comes to loans and financing, so it’s worth the work to get it into that “very good” or “excellent” category.
Knowing your credit score is the first step in buying a new vehicle. RightRide offers a complimentary, penalty-free credit health check so you know where you stand.