To develop a reliable permanent-magnet synchronous machine (PMSM) controller for electric vehicle application, detection of permanent-magnet (PM) demagnetization conditions is of significance. This paper explores the use of torque ripple for online PM demagnetization fault diagnosis using continuous wavelet transforms (CWT) and grey system theory (GST). First, a torque-ripple-based rotor flux linkage detection model considering electromagnetic noises is proposed, which employs CWT filtering, wavelet ridge spectrum, and torque ripple energy extraction. This model is able to reveal the torque variation and eliminate the effect of electromagnetic interferences. Second, GST is employed to facilitate the detection of demagnetization ratios and torque ripple energy pulsations caused by demagnetization. Third, a current regulation strategy is proposed to minimize the torque ripples induced by PM demagnetization, which contributes to making the approach feasible to interior PMSM (IPMSM). Furthermore, the proposed real-time irreversible demagnetization detection approach can identify the demagnetization fault under different operating conditions. The proposed approach and current regulation strategy are experimentally verified on a down-scaled laboratory IPMSM.