December 7, 2022

In times of soaring inflation, how much auto loan should you take out?

Owning a car can be convenient, but also expensive

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On average, a car is the second most expensive purchase Canadians will make. A key part of budgeting for one is to consider more than the initial price of the vehicle.

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After all, MNP’s 2022 Consumer Debt Index report finds that less than a quarter of Canadians are confident they could handle an unexpected car repair without taking on more debt.

To avoid falling into this trap, keep these tips in mind.

Cover fixed expenses first

Olivier Boyd, Licensed Insolvency Trustee at MNP, believes that fixed expenses should be prioritized.

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“You should be able to make ends meet and make sure all your other fixed expenses are covered,” Boyd advised. “Anything above that, then you’re entering territory where you’ll probably have to sacrifice something else,” he added.

In addition to using common sense, general wisdom says that people should budget 10-20% of their gross salary for their vehicle each year.

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For example, someone earning $30,000 a year probably shouldn’t budget more than $400 a month after deductions and taxes, and factoring in insurance, Boyd explained.

While this “rule of thumb” may apply everywhere, it could change in urban settings where housing costs could represent up to 50 or 60% of a person’s income. This situation would make buying a car a less sensible option, Boyd said.

This sentiment is echoed by Brian P. Doyle, chairman and co-founder of Doyle Salewski Inc. Doyle describes himself as a “pessimist” as he expects a lingering “major recession”. People who live in urban areas with improved public transportation would be better off getting rid of car expenses when possible, Doyle says.

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Budget for unforeseen expenses

Getting a car loan also means considering interest rates and credit scores, and the impact these cumulative expenses will have on your budget.

Doyle also stresses the importance of leaving some money aside for unforeseen expenses in case the “wheels come loose.” This emergency stash is highly recommended for people with older cars that will likely require maintenance.

Car owners should also be aware of how much money they have set aside for unexpected health care costs, as car expenses can eat away at this reserve.

“These (incidents) are a part of life and people don’t budget for them, so they don’t have the cushion,” Doyle said. “They often budget themselves down to, you know, the smallest amounts.”

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Avoid predatory interest rates

While interest rates of six to eight percent are reasonable for auto loans, any higher amount would put the buyer in the “risky category or second tier loan, the most common term we hear,” a Boyd said.

Equifax Canada’s 2022 Market Pulse Quarterly Credit Trends report found non-bank auto delinquencies increased 14.7% in the last quarter of 2021 (compared to the same period a year earlier). That means more people struggled to repay their auto loans.

Many dealerships or independent lenders will be happy to provide financing for vehicles that could cause users to have bad credit. Potential car buyers can avoid this trap and look into banking programs that cater to people who “clean up their act” and take charge of their debt.

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Read your documents carefully

Although the general advice is to get a car loan from a reputable dealer – who will most likely work with a credible financial institution – Doyle said people should be aware of hidden costs that can swell over time.

“There are a lot (car dealerships) that are still reputable, but there are some that are predatory, and that’s why people have to be careful,” Doyle warned, citing some payday loans as an example.

“We see this often in our practice,” Doyle added. “We get people paying 45%, 50%. They pay penalties. They take out a $500 loan and now they have to pay back $5,000.

Doyle also urged people to carefully review their documents, whether from a reputable lender or not, to avoid hidden or unexpected costs.

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“Is it going to be the interest rate? Will it be the penalties? Application fee ? Are you getting less for your trade than the true market value? Are you paying more for your new vehicle? »

Set your financial limits early

Doyle recalls an incident in 2006 when he wanted to buy a Mini Cooper as a present for his wife’s birthday. The monthly charge was $400. However, the bank at the time wanted to debit his bank account with any amount it deemed reasonable.

“I said no.’ They can charge me the loan amount, which was $400,” he said. “I’m not going to give them that right.

You can also avoid surprises by asking “so if I miss a payment, what happens?” For example, there are layaway plans where a buyer won’t have to pay interest for a year. However, once a payment is missed, the buyer will be liable for high interest on their remaining payments.

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Beware of negative equity

When asked what makes people unable to repay their loans, Boyd pointed to a common factor: “When negative equity is passed through.”

Negative equity what happens when people buy a new car but haven’t paid off their previous vehicle. The driver then often finds himself in default, since he is paying for two cars.

“So a car worth $15,000 or $20,000 might have a loan of $25,000 or $30,000 because the previous vehicles still have up to $10,000 in payments,” he said. Boyd.

Having a manageable loan means knowing your limits.

Deloitte’s 2021 Global Automotive Consumer Study showed that 35% of Canadians don’t research their car financing at all. Research and budget, if you want to avoid being a statistic yourself.

This article provides information only and should not be construed as advice. It is provided without warranty of any kind.

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