Some experts warn that a debt storm is brewing.
Many Canadians are increasingly opting to pay for their new vehicles with extended financing, and could find themselves underwater on their loans within the next few years.
In 2015, the average car loan had a term longer than 72 months, up from around 65 months in 2010. We are even seeing loans stretched out to 96 months.
Extended loan options often mean consumers are comfortable buying more car than they might be able to afford in the long run, which points to the strong SUV and pickup truck sales in Canada.
But consumers with low credit scores could face trouble repaying their loans, eventually leading to high interest rates and the potential to default.
Worse, many consumers may want to trade in their old vehicles for new ones, even though the loans are not paid off and the cars have depreciated in value. What happens is that outstanding balances on the previous loans are then rolled into the loans for the purchase of the new vehicles.
In essence, we end up with an endless cycle of automotive debt.
There’s no way this situation is sustainable for consumers or lenders, said the Financial Consumer Agency of Canada (FCAC) in its recent Auto Finance: Market Trends report, which paints a gloomy picture of automotive debt in Canada.
Sounds pretty scary, but is the situation all that bad?
The auto industry is aware of the trend and has been watching it play out for quite some time. It’s an issue being debated by analysts and economists, including Michael Hatch, Chief Economist for the Canadian Automobile Dealers Association (CADA).
Hatch isn’t disputing that the trend exists. But he finds the FCAC report misleading.
CADA responded to FCAC with a statement, which includes stats and facts not considered in the report.
For one, Hatch pointed out that auto loan delinquencies remain lower than all other forms of consumer debt in Canada, according to a recent report by credit reporting agency TransUnion.
While auto loan delinquency rates have spiked in places such as Alberta and Saskatchewan as a result of falling oil prices, nationally the level stands just above 1.3 per cent in Q4 of 2015. Anyone in the lending business knows that figure is quite low, said Hatch.
Since most automotive debt is financed at near zero or zero per cent, it’s a rational choice for consumers to amortize the loan over more time.
The FCAC report also explored the issue of negative equity, citing a J.D. Power stat that the percentage of consumers in that situation who are trading their cars has increased 50 per cent over the past five years. It went from 20 per cent in 2010 to 30 per cent in 2015.
But Hatch said negative equity only represents a minority of consumers, as the vast majority are able to pay back their loans, which explains the relatively low auto loan delinquency rates. About a quarter of Canada’s auto finance market is non-prime.
Another factor not considered in the FCAC report is that vehicles are staying on the road longer, thanks to improvements in technology, design and general consumer care.
Hatch’s argument is that today’s level of auto debt is sustainable for now, but it cannot carry on forever.
What about the dealer’s role in all of this?
The federal consumer watchdog has pointed the finger at auto dealers, accusing them of arranging customer loans that will make them the highest commission.
“The size of the commission, or the reserve, is one of the factors dealers consider when deciding which lender’s product is offered to the consumer,” said FCAC in the report.
Hatch takes issue with that. He argued it’s in the dealer’s best interest to sign up consumers for a financing product that is suitable and affordable. Having an unhappy, debt-ridden customer isn’t going to drum up repeat business.
We can expect some car buyers to read the FCAC report, and think that their dealers are pulling the
wool over their eyes — even though that’s not the case.
Unless there’s a complete overhaul of the current loan process and commission structure, there’s really not much dealers can do.
What they can control is the amount of information they provide to customers.
It all boils down to educating customers, being open and transparent about financing options, and as always, providing exceptional customer service in all aspects of the car buying experience.
