Buying a new or used car is often a costly venture that requires getting an auto loan — and with an auto loan comes credit qualifications. If you lack the creditworthiness to secure traditional financing for your new car, you may have to take an alternative route and consider a bad credit car loan. 

Bad credit car loans come with some risks, as you'll likely deal with less favourable terms. You’ll also have to be wary of lenders that prey on people with bad credit. Below, we outline the ins and outs of how your credit score is calculated, bad credit auto loans, and what to look out for when you need to borrow money for a new vehicle.

Understanding Credit Scores in Canada

There are two major credit bureaus that review and track credit history to help determine your credit score: Equifax and Transunion. 

In Canada, credit scores generally range from 300 to 900, according to Equifax. Higher scores indicate you've been good at managing your finances and debts. While your credit score is only part of the equation for getting approved for an auto loan — lenders also look at debt-to-income ratios, monthly income, and more — it can be a good gauge for whether you'll get approved and your available financing options. 

Canadian credit scores fall into four key categories: 

  • 760+: Excellent credit
  • 725-759: Very good credit
  • 660-724: Good credit
  • 560-660: Acceptable credit
  • Less than 560: Poor credit

Your credit rating takes into account five key variables

  • Payment history: Your payment history accounts for 35% of your credit score, and it's calculated based on your payments on debts, collections accounts, judgments, and other payment-related reports.
  • Used credit versus available credit: The amount of credit you’ve used versus your available credit is called your credit utilization ratio and it accounts for 30% of your credit score. It looks at the amount of credit you've used relative to the credit limit on your credit cards and other revolving debts. A credit utilization ratio of 30% is considered ideal. 
  • Length of credit history: Your length of credit history makes up 15% of your credit score. This is the amount of time your average credit account has been open. The longer your average length of credit history, the higher your score.
  • Public record: The information on your public record accounts for 10% of your credit score. This includes things like bankruptcy and other items that are publicly available.
  • Credit inquiries: When you apply for a new loan, credit card, or other form of credit, the lender will likely do a hard credit check. These can have a 10% impact on your credit score. A few hard credit inquiries on your credit report are no big deal, but too many can reduce your credit score. 

Why Bad Credit Leads to High-Interest Auto Loans

Your credit score is a numerical overview of how you manage your finances and debt. It also evaluates the risk of you not repaying the loan. For lenders, a lower credit score means a greater risk for defaulting — i.e., not repaying — the loan. 

When a bank takes on a high-risk borrower, it increases the interest rate to help offset the chances of that person defaulting on the loan. For borrowers, a higher interest rate on a bad credit auto loan results in higher monthly payments and a higher overall loan cost.

Typical Interest Rates for Bad Credit Car Loans

Typically, Canadian car shoppers can expect the average interest rate on a car loan to range from 4.5-10%. The lowest interest rates are for those with excellent, very good, or good credit scores. Anything below that and you fall to the subprime lending category with interest rates closer to the 10% range. Car shoppers with the worst credit will usually end up in the 10-30% interest rate range. 

To express the difference between a good credit auto loan and a bad credit loan, let's look at the monthly payment and total interest paid on a $20,000 car loan over 60 months. 

Let's say the individual with good credit gets a 4.5% interest rate. Their monthly payment would be $372.86. As such, they'd pay $2,371.62 in interest over the course of the loan. 

If a person with a low credit score gets the same loan terms and loan amount but a 15% interest rate, their loan payments would be $424.94 per month. Plus, they’d pay $5,496.45 in interest over the life of the loan. That's $53.08 more in monthly car payments and an extra $3,124.83 in total interest. 

Beyond the higher interest rate, having a bad credit score often means you must put a larger down payment on a vehicle.

Bad Credit and Predatory Lending

Predatory lending is a big issue nationwide, as folks with limited income or bad credit scores may struggle to get financing and settle for the first lender that'll approve them. In some cases, companies that approve the more difficult credit cases aren't the most ethical and may use a borrower’s desperation as a means to profit. 

If you have a lower credit score and are looking for an auto loan, beware of the following common predatory auto financing tactics: 

  • Bait and switch: In this instance, the lender sold and pre-approved the borrower on specific loan terms throughout the entire process, but then sneaks in less favourable terms — like inflated interest rates — when it comes time to sign the documents. The lender hopes the borrower either won’t notice the new terms or simply accepts them and signs the documents. 
  • Inadequate disclosures: In some cases, the lender may outright hide or obscure the loan terms, such as fees and other costs, resulting in the borrower signing up for a loan with unfavourable terms.
  • Loan packing: Lenders may also sell a borrower on a specific interest rate but then pack the loan with unnecessary and unapproved extras (such as loan insurance) without informing them. Alternatively, a lender may inaccurately tell the borrower these add-ons are required for approval. Car dealerships can also participate in loan packing by claiming a lender requires an extended warranty or GAP insurance
  • Buried balloon payments: Balloon payments — a significantly larger monthly payment at the end of a loan — sometimes happen in normal car financing, but the lender should always clearly disclose them. Predatory lenders often offer a strong rate and payment upfront only to add a balloon payment at the end that's multiple times larger than the normal payment to compensate for the lower rate you got upfront. The worst part is the balloon payment is either buried in the terms or left out altogether. 

The Right Car Loan Can Help Rebuild Your Credit Situation

Bad credit isn't a permanent thing. You can fix it over time by proving you can manage your debts. There are several ways to rebuild your credit over time to avoid having to settle for a bad credit auto loan, including: 

  • Credit-builder loans
  • Secured credit cards
  • Debt consolidation

An auto loan can also help rebuild your credit. By getting the right auto loan terms and making on-time payments to the financial institution that issued the loan, you may increase your credit score. 

Once you get your credit score to a better place, you may be able to refinance the vehicle at a lower interest rate or use the vehicle as a trade-in to get a newer vehicle with a better interest rate. 

Clutch's Transparent Auto Financing Can Help

At Clutch, we're here to make your pre-owned car shopping experience as enjoyable as possible. From our 100% online shopping process to our 10-day risk-free trial period, we're here to help. 

We can also help you secure legitimate car financing without worrying about unfavourable terms or falling victim to predatory lending practices. Plus, you can complete the credit application online and have a response in just a few minutes. We have options for all types of credit, including for folks with low credit scores or no credit at all. 

To get started, find the quality pre-owned vehicle that's right for you, click on it to review details, then choose "Apply for financing." Complete all the questions asked throughout the application process and get your pre-approval and estimated loan terms at the end.