The essential guide to vehicle financing

What is financing?

Financing a car means borrowing money to buy it.

Most people don’t have the cash on hand to buy a car in full. So, they take out a loan with the new car as collateral. They pay it back over time, plus interest — that’s financing. But, like any loan, you’ll have to qualify for it.

Requirements for financing

When you apply for a car loan, the lender will look at several factors and either approve or deny the application. If it’s approved, they’ll use the same factors to determine the loan’s interest rate.

1. Credit score. Pretty much any lender will run a credit check as part of a loan application. A good credit score will help secure a better interest rate. There’s no specific credit score cutoff, as each lender is different. But, a credit score of at least 670 puts you in the “good” range — anything below that, and you may not qualify for credit from all lenders (at least not at the best interest rates).²
2. Income. You’ll usually need to have a gross income of at least $1,200–$1,800 per month to qualify for a car loan.
3. Age. Minors can’t get car loans. To qualify for financing, the applicant has to be at least 18 or 19 years old, depending on the province.
4. Driver’s licence. You’ll need to have a valid driver’s licence. Depending on the lender, a learner’s licence may not be acceptable.
5. Car insurance. Before they release any funds, the lender will want to see that you’ve purchased insurance for the vehicle (we’ll get into insurance further down).
6. Documentation. Lenders won’t just take your word for it — you’ll need to be able to prove all of the above. Bank statements, pay stubs, or tax returns can all prove your income or employment history. You may need proof of address, which could be utility bills or bank statements in your name. To run the credit check, the lender will need your social insurance number, address, phone number, and date of birth.

There are two ways to get a car loan: through the dealership or a financial institution.

Dealership financing

The most common way to finance a car is to arrange it directly with the car dealership. Dealerships don’t generally offer the loan themselves. Rather, they work with a third party, like the vehicle manufacturer’s financing division or an independent financing company.

There are several benefits to arranging your financing through the car dealership:

1. It’s faster. Most of the time, dealerships can get your loan approved right away, letting you drive your new car off the lot right then and there.
2. They’re often more lenient when it comes to low credit scores and other application details.
3. You’ll often have access to manufacturer incentives like rebates or reduced financing costs.

The downside of car dealership financing is that the interest rates are often higher than those from banks. You’ll also probably need to make a downpayment.

Bank or credit union financing

Many car buyers prefer to arrange for a loan directly with their bank or with another financial institution. There are also benefits to financing a car this way:

1. Banks often offer lower interest rates, especially if the applicant has a strong credit rating.
2. Banks may offer longer repayment terms, resulting in lower monthly payments.
3. You may not need to make a down payment on a bank loan.

Of course, bank loans come with downsides, too. Banks are stricter with credit ratings and other requirements. It’s also slower; while dealerships can arrange for same-day financing, you probably won’t be able to swing that with a bank.

Ultimately, the decision will come down to cost — who’s offering the best terms for your loan? Aside from that, there isn’t a huge difference as to where the loan comes from.

Secured vs. unsecured loans

There’s one more thing to know about financing a car: the difference between secured loans and unsecured loans.

A secured loan is backed by collateral. That is, there’s some asset that the bank can legally take possession of if the borrower stops making payments. This is known as a lien. Financing a car, especially a new one, is always a secured loan, with the car being the collateral. Secured loans usually have much lower interest rates and are easier to qualify for.

With a secured car loan, the lender effectively owns the car until the loan is paid off. Accordingly, they may impose certain restrictions, like requiring certain optional car insurance coverages.

An unsecured loan is just a loan with the funds not attached to anything in particular. If you take out an unsecured loan to buy your car, you do own it outright — but you’re still responsible for paying off the loan.

Benefits and drawbacks of financing

Financing is the most popular method of paying for a car in Canada. Why is that?

Pros and cons of financing

Pros Cheaper than leasing in the long term You can buy a car that you wouldn’t be able to afford with an upfront cash payment Eventually, you pay off the loan and the car is yours You build equity with your payments Timely loan payments will improve your credit score If you wish, you can usually pay off the loan early

Cons More expensive than financing in the short term You’ll pay interest on top of the purchase price of the vehicle You may need to make a down payment The vehicle’s value may be lower than the amount you owe on it You need decent credit history and income to be approved

Financing vs. leasing

Financing is buying a car with borrowed money. Leasing, however, isn’t technically buying a car at all — it’s basically long-term renting.

Check out our guide to leasing a car if you want to learn about it more in-depth.

Here are the main differences between financing and leasing:

• Cost: The monthly payments for a lease are usually lower than loan payments. However, loan payments eventually become zero, and you’ll still have the car. When the lease ends, you’ll have to renew it or get a new lease. This is why leases are cheaper month-to-month, but financing is cheaper long-term.
• Ownership: Your finance payments build equity in the car. When the loan’s paid off, the car is yours. Lease payments don’t build equity, and you’ll never own the car unless you arrange to buy it at the end of the lease.
• Maintenance: Lease agreements often include scheduled maintenance. Plus, with a lease, you’ll return the car before long-term wear and tear issues crop up. When you finance a car, you’ll be responsible for repair and maintenance costs, especially after the warranty runs out.
• Getting rid of the car: If you wish to break a lease agreement early, you’ll either need to find someone to take over the lease or pay a penalty. It’s possible to sell a financed car, but you still need to pay off the loan.
• Limitations: When you lease a vehicle, the agreement will limit how many kilometres you can drive each year. A lease also requires that you return the car with no excess wear and tear or modifications. No mileage limits exist for a financed vehicle, though dealership loans may restrict modifications to some degree.

Deciding whether to finance a car

Now you know the difference between leasing and financing. Which method should you use for your new car?

Really, the decision comes down to a simple calculation: which is going to cost you less money? If you’ve got an idea of which car you want, you can use an online calculator to plug in all the variables and see how the numbers shake out.

But, for most people, financing makes more sense than leasing. While lower payments for leases are attractive, those payments will never end. Eventually, loan payments are finished, and you’ll have a car (though its value will have depreciated greatly from the purchase price).

There are situations where leasing makes more sense, of course. If you know you always want to drive a new-ish car, leasing is the way. Or, if you use your vehicle for work, there are tax benefits to leasing.

Financing used vehicles

So far, we’ve mostly talked about buying new vehicles. But you can also finance a used car. In fact, there are many good reasons to do so.

Financing a used car works just like it does for a new one. You’ll still be able to get financing through a dealership or a bank. It’s also easier to qualify for a loan since it should be for a smaller amount.

You can also get a loan if you’re looking to buy a vehicle from a person (a private sale). With a private sale, you don’t necessarily need to get a secured loan if you can qualify for (and afford) an unsecured loan. Another option is to open a line of credit with your bank to finance the deal.

Insurance considerations

When you finance your vehicle purchase, there are some car insurance implications to keep in mind.

Car insurance is always mandatory. But, a couple of optional coverages will become mandatory if you finance your car. Because of the lender’s interest in the vehicle, they will require you to buy both comprehensive and collision coverage. Alternatively, you can get all perils coverage, which includes both.

You’ll also need to have an insurance policy in place before the lender releases any funds. If you’re in a hurry, you can buy car insurance online. That will help you get behind the wheel quickly.

These insurance requirements won’t apply if you use an unsecured loan or line of credit to buy the car. You will still need liability insurance to drive it off the lot — it’s mandatory by law.

Commonly asked questions

What is the average monthly car payment in Canada?

As of 2023, average monthly vehicle loan payments were $840.³ But, almost 30% of people financing their vehicle pay more than $1,000 monthly.⁴ These figures apply to new vehicle loans; financing a used vehicle would reduce the monthly payments in line with the lower purchase price.

Can you sell a car you’re financing?

You can sell a car that’s currently financed, but it’s a little more complex than selling a car that you own.

You’ll need to get a statement from your lender showing exactly how much you still owe on the car. Before the car changes hands, you’ll need to pay that amount off — it’s very difficult to sell a car with a lien on it, and you’re legally required to inform potential buyers about that lien. It’s possible to sell the car and use the proceeds from the sale to pay off the loan.⁵ Just ensure that you do so immediately, as the new owner needs the vehicle to be lien-free before registering it.⁶

Is financing a car a bad idea?

Like any financial decision, financing a vehicle isn’t inherently bad or good — it all depends on the circumstances. If you can afford the payments and are okay with the interest, there’s nothing wrong with financing. At least your payments are building equity in the vehicle compared to leasing. Plus, car loan payments help build up your credit score.

If you’d prefer to avoid paying interest, or you’re worried about owing more on the car than it’s worth, consider paying cash for a used vehicle instead.

Sources

1. Insurance Insight. “The growing importance of high-quality debt protection for Canadian automotive consumers.” insuranceinsight.ca, insuranceinsight.ca/wp-content/uploads/2021/03/Insight-WhitePaper-2020-Final-Digital.pdf. Accessed 8 Oct. 2024.
2. Equifax. “What is a Good Credit Score?” equifax.com, equifax.com/personal/education/credit/score/articles/-/learn/what-is-a-good-credit-score. Accessed 8 Oct. 2024.
3. Fortier-Labonté, Alexandre, and McGillivray, Marisa. “The evolving landscape of Canadian lending: Key trends in mortgage and non-mortgage loans.” www150.statcan.gc.ca, 14 Aug. 2024, www150.statcan.gc.ca/n1/pub/11-621-m/11-621-m2024009-eng.htm.
4. Carrick, Rob. “High interest rates mean the new normal in vehicle buying is a monthly payment in the $1,000 range.” The Globe and Mail, 12 Jul. 2024, theglobeandmail.com/investing/personal-finance/article-car-payments-high-interests.
5. People’s Law School. “Selling a used car.” peopleslawschool.ca, www.peopleslawschool.ca/selling-used-car. Accessed 8 Oct. 2024.
6. Financial Consumer Agency of Canada. “Risks associated with car liens.” canada.ca, www.canada.ca/en/financial-consumer-agency/services/loans/financing-car/risks-car-liens.html. Accessed 8 Oct. 2024.

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