Money Smart: The ins and outs of getting a car loan

During her two years as a bank teller, Kathryn-Lynn Raskina met a lot of people who were drowning in debt and struggling to pay their bills. It wasn’t because they weren’t making enough money. It was because they didn’t know the first thing about debt or about managing their money. She doesn’t want you to be one of those people. She wants you to graduate money smart.

I’ll never forget my first car. She was a 2012 Ford Focus Titanium hatchback, used and fire-hydrant yellow — a totally beauty. For a summer, she was all mine. My best memories were of riding her down old country roads with the windows open, the warm breeze blowing through my hair, my favourite tunes blasting. It was amazing not having to rely on public transportation, family, or friends to get around. I loved being able to go wherever, whenever I wanted. Having her was a freedom.

But like all freedoms, she came with a cost. A cost I paid for, with the help of my parents, through a car loan.

Since most of us don’t have the money today to pay off a car in full, we need to borrow the money from a bank or dealership. This is called a car loan. How it works is your bank or dealership gives you the money upfront, you use that money to buy your car and then you pay them back that money over a certain period in monthly or bi-monthly payments. To account for the risk they are taking on in giving you that money upfront, they charge you interest with every car payment on the money you still owe.

To get approved for a car loan, you have to show your lender that you are capable of making payments. This is where your high credit score that you accumulated through making your monthly payments on your credit card, comes in.

Lenders also want to be assured that you have a steady income and that you aren’t heavily indebted. Since this description doesn’t fit most student borrowers, François Courcy, the director of operations at iA Financial Group, says some lenders will want a parent or guardian to be a co-signer on your loan. This, of course, depends on how much your car costs. If you neighbour across the street, or your cousin twice removed is willing to sell you his old beat up car for close to nothing you may be able to handle the loan payments yourself.

Loans are available with a variety of terms to choose from. The term is the length of the loan agreement. It usually ranges from one to five years. Courcy says you need to think ahead and make sure that your term matches the amount of time you need to have your car for. For instance, the dirt box two-door that gets you from A to B in university, may not be the car you want to be driving four years down the road when you get promoted at the company you are working at.

If your term is too long you may end up in a situation where the money you can get from selling your car isn’t enough to pay off the remaining balance on your car loan. This is called having negative equity or being “underwater” on your loan, something you can avoid by planning ahead.

The interest rate on your car loan is determined by how big the loan is, its term and your credit risk profile. Usually the higher the risk, the higher the interest rate. If you get your loan from the bank, it’s likely they will charge you between three to nine per cent interest.

When you get a car loan you get to choose between a variable or fixed rate of interest.

A variable rate means that your rate can go up or down if the Bank of Canada decides to change it. This works to your advantage if rates decrease because it will mean more of your payment will go to paying off your principal instead of towards interest. This will allow you to pay off your loan faster.

On the other hand, with a fixed rate, your rate of interest stays the same throughout your entire term. This means your payment will always be the same and you will know from day one how long it will take you to pay off your debt. Since we are currently living in a time of historically low interest rates, you are best to go with a fixed rate on your car loan says Courcy. Rates are so low right now that the only place for them to go is up he says. This is good thing because it means you can lock in a low interest rate.

Two weeks ago, I wrote about how money loses its value. Well, a car loses its value even faster than money does. The value of your car drops the moment you drive your car out from the lot. Cars normally lose 15-20 per cent of its value every year. Make sure to keep this in mind. If it is possible for you to walk, bike or take public transit to work or school, do it. A car is expensive. Your pocketbook will thank you.

Like any other debt, you want to make sure you are making your payments for your car loan on time and that you only take on a debt that you know you can pay off. “ Buy within your means,” Courcy says. This is of utmost importance. Your first car shouldn’t be your dream car. It should have some quirks, such as being a terrible colour-like my fire hydrant yellow hatchback — or having a sticky door. Trust me, it’s those cars that make for the best stories down the road.

Featured image by Augustine Ng