August 7, 2015
According to a report just published by the Automobile Consumer Coalition (ACC), seven years is now the norm for new vehicle loan. As recently as 2008, the most popular new car loans were for five or six years. The ACC report, prepared for the federal Office of Consumer Affairs, observes that longer loans have contributed substantially to record sales of new vehicles in Canada by permitting lower monthly payments.
Long 84 and 96 month auto loans mask the true cost of buying a vehicle, and many consumers use them to "upsize" their purchase to buy vehicles that would be beyond their reach using the previously-common 60 month loan. For the same payment paid over an additional two years, buyers are migrating out of compact cars into more expensive compact SUVs. The report predicts an eventual contraction in the market, and consumer pain when it occurs.
A drawback of extra-long financing is that the vehicle is almost always worth less than the balance of the loan for the first five or six years. This means the customer is locked into the loan, or will have to cover the shortfall if they resell their vehicle early. In the car business, this is called "negative equity," or more informally, being “upside down” in your loan.
Among other findings in the report:
- One third of consumers surveyed have no money set aside for unexpected car repairs. Driving a paid-up used vehicle can be a risky proposition for this class of consumer, as they`re just not prepared for a breakdown. For them, the predictability of a fixed monthly financing or lease payment beats the lower operating cost of keeping a used vehicle.
- Some consumers responding to the survey admitted their existing car loan was longer than they would recommend to friend.
- Many consumers are trading in vehicles before they are fully paid off, and rolling the "negative equity" into new extra-long auto loans. In that situation, the buyer is financing the second vehicle with two loans and will be even more "upside down" if they attempt to trade before the loan is paid up.
- Almost a third of auto financing in the used car market is now of the subprime category with effective interest rates of 15 to 30 percent or more. Consumers in this segment pay high interest rates and fees, and already have stressed credit; they will be especially vulnerable to the next financial correction.
The ACC report calls for more oversight by government and more responsible lending by the banks and automakers to allow the market to cool gently instead of bursting. The full report is posted on the ACC website.
With current very low interest rates, as low as 0% for 84 months, a longer auto loan can be a sensible choice. The APA recommends you use the interest savings to pay off other debt or set some money aside, say $50 a month, for savings. In the event you want to change vehicles early, choosing the right vehicle is more important with a longer loan, because the negative equity for brands with poor resale value is larger.
Finally, if the automaker provides the option of a cash rebate or a subsidized interest rate, take a closer look at the cash deal. If your credit score is good, it may be cheaper overall to take the rebate and finance at today`s historically low market rates. With a cash rebate, savings are earned immediately -- with low-interest financing, the benefit accrues gradually over the term of the loan.