When you're in the market for a quality new or pre-owned car in Canada, a loan is usually the only way to pull it off without years of saving. Unfortunately, applying for car loans can lead to rejections.
Each lender has its set of rules for approving car loans, so the rejections sometimes leave you confused and wondering, "Why was my car loan rejected?" Below, we'll explore the common reasons car loans are rejected and how to overcome that rejection.
When applying for an auto loan, there's a wide range of variables the lender looks at when they pull your credit history and check your income. These factors range from your payment history to your credit score to your debt-to-income ratio (DTI ratio) and beyond.
If any of these variables are off, it can trigger a rejection, leaving you without the new car you need.
Let's look at a few possible reasons your car loan was rejected.
When you apply for an auto loan in Canada, one of the first things the lender will do is review your credit score. While there are various credit scoring models in Canada, the one most Canadian lenders use is FICO.
Your FICO score can range from 300 to 900, and anything below a 580 is considered poor or subprime. Very few auto lenders will approve you with bad credit, as you represent too significant of a risk to finance. The lender's key concern is you'll default on the loan, leaving them to repossess and attempt to sell your vehicle to recoup their costs.
If you have fair credit, a 580 through 669, you may find trouble getting approved on the lower end of the score range. However, you can likely get approved at the upper end of the range but only with specialty lenders that have higher interest rates.
One of the paradoxes of credit is your loan application can be denied for having no credit. Having no credit means you've never used credit before or it's been so long since you've used credit that you no longer have a score.
Instead of coming back as a zero on your credit score, you'll have an "indeterminable" score. Logic may lead you to believe a lender may see this as a good thing, but in reality, lenders view this lack of credit as high risk because your fiscal responsibility is shrouded in mystery.
Without other factors improving your application, such as a high down payment or income, a lender may reject you based on having no credit.
Your income can also be a cause for rejection. Of course, insufficient income is a cause for rejection, but you can also get rejected based on sporadic or hard-to-prove income.
For example, if you're a salesperson who works on commission only, a lender may need months' worth of paystubs to establish an income trend. If those stubs show weeks and months of no commission, the lender may reject you based on sporadic income.
You also may have plenty of income but difficulty proving it. This is often the case with freelancers, contractors, and the self-employed who get paid directly from clients and don't receive pay stubs. In these cases, the lender may want to see previous years' Proof of Income Statements or bank statements to prove your claimed income. If you lack these items or they don't match with the income you're claiming, the lender may reject your credit application.
When filling out an auto financing application, it's critical that you be as honest as possible. The lender may look into all of your claims. If you provide incorrect information on your loan application, including income, home ownership status, time on the job, and more, the lender may reject your car loan application.
In some cases, the lender may simply ask for the corrected information. However, lying on a credit application is a serious issue, so most lenders will view this as a major red flag and deny your car loan.
Lenders carefully consider your DTI, as this is a clear indicator of whether or not you can afford the monthly payments. If your DTI ratio exceeds the bank's limitations, you can expect a car loan rejection.
An ideal DTI ratio is under 36%, but many lenders will approve auto loans with DTI ratios as high as 48%.
Keep in mind that the DTI ratio auto lenders consider also includes the loan you're applying for. So, your DTI ratio may be fine now, but the new loan may exceed the lender's limitations.
In some cases, it's simply the loan amount that's getting in the way, causing your car loan to be rejected. This usually combines with other issues, like your DTI ratio or income, but the lender may tell the dealership it can approve a lower amount based on your credit, income, and current debt.
When your car loan is rejected, it's easy to get upset or confused and simply give up. Instead of getting angry, find out what the issue is and attempt to rectify it.
When your car loan is rejected, it's important to try to sort out why. Speak with the finance department at the dealership and see if the lender gave them a reason for the rejection.
Not every lender will offer a reason, but some may lay out what the issue was. In some cases, these are issues you can fix immediately, like proof of income, inaccuracies in your application, or omitted details in your application. If it's a simple issue like this, find out what the lender needs and resubmit the application with the lender's needs met.
Other issues may require more long-term fixes, like an unfavourable credit report, collections accounts, high credit card balances, high DTI ratio, and more. In this case, find out what the lender needs to approve you so you have a target.
Regardless of whether it's a simple fix or something more serious, knowing the issue gives you a head start on fixing it.
When you get that initial auto loan rejection, it can be disheartening. However, there may be a few ways you flip that rejection into an approval now.
A cosigner is someone willing to sign on a car loan with you. While they may not be a partial owner of the car or make the car payments, they are sharing the financial responsibility of the car loan with you.
The bank will consider the cosigner's income, credit score, credit report, DTI ratio, and more when reviewing the loan. If the cosigner's financials are acceptable, the lender may approve the car loan.
Keep in mind that the cosigner bears the same financial responsibility as the main borrower. This means if you get a negative mark on your credit report due to a late payment, the cosigner may also get a negative mark. And if your vehicle gets repossessed, the cosigner may also get a repossession on their record.
If the bank is not willing to approve the loan amount you've requested, you can easily fix this by reducing the overall vehicle cost in one of two ways.
First, if you have extra savings, you can apply that cash to your down payment, lowering the total amount financed to a level the lender is comfortable with.
Second, you can choose a less expensive vehicle, bringing the total amount financed to an acceptable level.
Banks apply interest rates based on your credit score and report, but they also use the vehicle to set the rate. Generally, an older vehicle has a higher interest rate, which can significantly increase your monthly payment.
For example, financing a $25,000 car at 6% for 60 months costs $483 per month, while a 5% loan for the same time will cost only $472 per month. By going with a slightly newer vehicle, you may be able to get approved if you just barely crossed over the lender's DTI ratio limits.
You can also look into stretching out the car payments for longer. For example, if you stretched the 5% interest loan above out to 72 months, your payment would fall to just $403 per month. Even if the loan provider increased your interest to 6% for extending the terms, you'd still pay just $414 per month. This could also be enough to get you under the lender's DTI requirements.
If the immediate options to get loan approval don't work, you may have to take longer-term steps to get car financing. Below are some solutions to common reasons your car loan was rejected.
A big reason car loans get rejected is too much outstanding debt that pushes your DTI ratio too high. In many cases, the only solution to this is to start paying down your debt.
Create a budget that allows you to funnel some extra cash to your debts. Continue paying off your debts one by one until you've gotten your DTI ratio low enough for approval.
Sometimes, your credit score is just too low to approve, and a cosigner is unavailable or wouldn't help get you approved. At this point, building your credit score will be key to getting approved.
Here are some ways to build a good credit score.
Your FICO score has five weighted categories, and the biggest factor is payment history. It accounts for 35% of your FICO score, so focusing on on-time payments is key to building good credit.
The amount owed is the second highest factor in your FICO score at 30%. A key portion of your amounts owed is your credit utilization rate — the balance on your credit cards relative to your credit limit.
For example, if you have a $10,000 limit and a $5,000 credit card balance, you have a 50% credit utilization rate.
Ideally, you want to keep this below 30%, so pay down your debts until you are under 30%, and you may see your credit score increase.
If the holdup is because your loan payment or amount is too high, you can reduce both with a larger down payment. If you can't immediately pad your down payment with previous savings or lower the price of the vehicle you're financing, you'll need to start a savings plan to accumulate the additional down payment.
You can also aim to improve your overall financial situation by increasing your income. You can go the traditional route of working to get a promotion or finding a new, higher-paying job, but that can take a while.
The alternative is to jump into the gig economy. These side gigs include ride-sharing, grocery and food delivery, freelancing, and more, and they can give you the income boost you need to get approved for a car loan.
As a side-gig worker, the lender will want to see consistent, provable income, so you'll need to work at this job through the remainder of the tax year so it shows on the following year's Proof of Income Statement from the Canada Revenue Agency.
Are you not sure if you're in a position to finance a car but want to see if you can get approved without it impacting your credit? Clutch's pre-qualification system can check if you what rate you prequalify for on an auto loan with one of our lenders with no impact on your credit score.
Once you're pre-qualified, check out our inventory of pre-owned cars and find the vehicle you love. You can then complete the entire purchase process online, skipping the hassle and pressure of a traditional car dealer.
Plus, all of our quality pre-owned vehicles have been through a 210-point inspection and reconditioning process. They also include a 90-day or 6,000-km warranty and a 10-day risk-free test-own period. If you don't love your Clutch vehicle in the first 10 days, you can return it for a full money-back refund or exchange it for another vehicle.