Auto Loans Debt: A Risk to Canada?

Auto Loans Debt could be the biggest financial threat to Canada.

When it comes to shopping for a car, most people don’t buy on price – they buy the payment.

But a new study says most drivers can’t really afford to buy a set of wheels – even the gently used vehicles most financial guides recommend – to begin with.

American comparison site analyzed 25 million used cars sold in the 50 largest metropolitan areas in the U.S. and concluded most of those purchases would leave the average household over-extended.

Things are likely worse on this side of the border since comparisons between Canada and U.S. prices regularly show that Canadians pay significantly more than Americans for their vehicles.

Too Much Car, Too Little Income

As a baseline, the study used the ‘20/4/10’ rubric, which calls for used car buyers to put down 20 per cent, take out a loan for no longer than four years and spend no more 10 per cent (15 per cent if you add in maintenance and car insurance) of their monthly income on a car payment.

Using that formula, it’s clear that many car buyers are juggling payments that are higher than they can really handle, and for a term far longer than ideal, to get behind the wheel.

The reality for both used and new car buyers is that the days of taking out a car loan and paying it off within 48 months are long gone.

Instead, faced with less disposable income, Canadians are opting for loans with bi-weekly or even weekly payments that mask underlying costs like interest and depreciation and make car loans look a lot cheaper than they really are.

The 8-Year Car Loan

Some car loans actually extend for as long as eight years, which is approaching the average lifespan of a vehicle in Canada. What’s more, the average payment on a car loan now stands at a whopping $549 a month, according to the latest data from J.D. Power & Associates.

The problem with opting for longer repayment terms is that your car may actually lose its value faster than you can pay off the loan.

While drivers have been making their payments so far, economic blips – like a sudden jump in interest rates or unemployment – could change things in a hurry, leaving them or their banks holding the bag, according to a report from ratings agency Moody’s.

The Moody’s report says the combination of low interest rates and longer terms has been encouraging drivers to opt for more expensive, and often imported, rides with little thought to the future.

Too Many Loans Underwater

If default rates rise, however, lenders could be left owning cars that are worth less than they’re owed – a potential worry for banks that have been depending on auto financing profits, Moody’s warns.

Growth in auto loans has outpaced that of mortgages, credit cards, and personal lines of credit over the last seven years, according to the report.

 Also read: Canadian Mortgage Debt $11 Billion Less Than Thought>

The good news is that used-car prices may finally be heading down. A few years ago, because money was tight, fewer buyers were purchasing new cars. That meant a shrinking supply of used cars, as there were fewer trade-ins or vehicles coming off lease.

Leasing subsequently picked up though, with more cars coming back to dealerships as used cars.

“The abundance of returned lease cars should result in used cars coming off their historical highs of recent years, representing good buys for consumers,” predicts analyst Michelle Krebs.







Related Topics

Debt Repayment / Economic News / Personal Finance

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