WHILE RISING CONSUMER DEBT IS A CONCERN IN CANADA, THE SITUATION ISN’T NECESSARILY AS GRAVE AS SOME PREDICT
Among the issues and threats hanging over the auto industry in particular and the economy in general, few have gotten more attention in recent years than evolving lending practices, both in our industry and throughout the economy at large. Personal debt levels — despite modest recent decreases — have continued to approach record highs in 2013 despite all the warnings consumers receive from journalists and political leaders to reign in consumer lending.
As an industry we can’t ignore the fact that the single biggest driver of increased personal debt in the past decade has been automotive-related lending: people are taking out larger and longer-term loans to finance their vehicle purchases. It’s worth asking: what does this mean for the industry and the economy in the long term?
The most striking way in which automotive financing has evolved in the past generation has been twofold: the dual proliferation of very low and zero per cent loans and ever-longer terms. Both help explain the degree to which consumers have increasingly opted to finance new vehicle purchases in recent years, even those consumers with sufficient cash on hand to purchase vehicles outright. After all, at zero per cent it makes sense to take on debt even if you have the cash in the bank.
UNDERWATER
Even with new car prices decreasing relative to income levels, the average consumer puts less “skin in the game” on automotive purchases today than in the past and finances a greater portion of the transaction. Terms that stretch out as many as eight years at zero per cent keep monthly payments affordable, but put vehicle owners at risk of finding themselves underwater on the car: owing more on it than it is worth. Though today’s new cars don’t depreciate at the same rate of those in earlier generations, ever-longer terms with little cash injection on the part of the customer can — and often do — result in negative equity for Canadian car owners.
There are many in the industry who have predicted that the twin forces of lower rates and longer loan terms would store up serious downside risk for the industry over the medium and long terms. Longer terms (and longer-lasting vehicles), the argument runs, will decrease the frequency with which consumers replace their vehicles and therefore negatively impact sales in the future. So far as most analysts can tell, however, that hasn’t yet happened. For evidence we need to look no further than this year’s record pace of new car sales in Canada and a very healthy recovery in sales south of the border.
ALWAYS AN AUDIENCE
It would be a mistake to view this issue in too cavalier a manner. Personal debt cannot keep on going up forever, nor can automotive loan terms. There is and will remain, however, a significant portion of the Canadian automotive market that will upgrade to the newest model every few years regardless of the dynamics at play, or on the debt incurred the last time around.
Though absolute debt levels and the oft-cited debt to income ratio remain elevated, the vast majority of this debt is held by higher-income Canadians who can easily afford it at today’s low rates and the higher rates certain to come in the future. It is that demographic that will drive new car demand regardless of the worries often expressed at the proliferation of zero rates and decade-long terms. Though new cars are marketed to a large degree at younger buyers, the reality of the industry is that the majority of sales take place with middle-aged and older customers who have larger incomes and more wealth at hand than your typical 20-or-30-something.
Another telling statistic is that while personal debt levels have reached record highs, rates of default on consumer debt are at historically low levels. These two indicators can’t diverge forever: eventually higher debt-to-income ratios will lead to more defaults, especially as rates start to creep up. But it does underscore the fact that the lion’s share of debt in Canada is held by consumers that can comfortably afford it.
While it would not be wise for consumers to keep piling on the debt indefinitely, there’s nothing magic about our current level of indebtedness, after which point economic Armageddon looms. Plenty of wealthy countries have gotten by just fine with debt-to-income ratios much higher than our own. So take media warnings that we’re headed off a debt cliff with a grain of salt.
