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Increasingly longer-term car loans flagged as growing problem by industry watchdog

Recovery Agent Amanda Husted (R), returns a vehicle to an owner after he paid for its release. (Getty)
Recovery Agent Amanda Husted (R), returns a vehicle to an owner after he paid for its release. (Getty)

Canadians bought or leased a record 1.8 million new cars and light trucks last year, the vast majority of them financed through loans.

Now a consumer watchdog organization is warning that the ever-longer terms on auto loans and the use of subprime loans put at least some car buyers at risk of taking a financial bath.

A report by the Automobile Consumer Coalition produced with funding from Industry Canada’s Office of Consumer Affairs says most auto-purchase financing is for terms of more than 72 months (six years), with 84-month periods (seven years) not uncommon. That’s far from the three-year loan your father’s Oldsmobile was probably financed with.

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The longer term taken to pay off a loan not only means buyers are paying more in interest but they also risk being “upside down” on the loan. Depreciation could bite them if they have to replace or dispose of the car before it’s paid off, like if the car had to be written off in an accident, or if their financial circumstances changed due to job loss.

The report also claims up to 35 per cent of auto lending is subprime, meaning borrowers with low credit ratings are charged higher interest rates to account for the risk and face stiff penalties for a late payment or repossession if they miss one.

The report, submitted to the federal agency in June and made public this month, makes several recommendations aimed at giving borrowers more information about loan terms. They also encourage lenders and auto dealers to guard against predatory lending practices and to stiffen automotive lending requirements along the same lines as for the housing market.

But a leading Canadian auto industry analyst argues the report exaggerates the risk of both issues in the Canadian market. While not playing down their seriousness for some buyers, Dennis DesRosiers said the scope of the problem is comparatively small in a market that last year accounted for $55 billion in new-vehicle borrowing and $35 billion for used vehicles.

“You think you could find problems? Absolutely,” he said. “Are they permeating the industry in something that could result in catastrophic issues and need legislation? Definitely no.”


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DesRosiers also questioned some of the data used in the coalition’s report, which he said doesn’t jibe with figures he and other industry watchers have gathered.

“When you set out to show that there’s a problem in a multi-billion-dollar market, of course you’re going to find problems,” DesRosiers said in an interview with Yahoo Canada.

Report intended to raise consumer awareness

Industry Canada is under no obligation to do anything with the report, produced under a program designed to give consumers a stronger role in the marketplace through consumer groups’ research and analysis.

“The views expressed in the report … are those of the organization and independent from those of Industry Canada or the Government of Canada,”  Industry Canada spokesperson Omar Sayarh said via email.

Most of the recommendations are aimed at lenders and the auto industry, as well as provincial governments that regulate consumer lending. The coalition report’s author, Shahram Prymak, told Yahoo Canada the Ontario government will look at applying some of them.

Regardless of who thinks the report is relevant, the underlying issue of ever-longer auto loan terms does beg the question: what exactly is behind them?

DesRosiers said a combination of rising vehicle prices and sales competition pushed automakers to find ways to get more Canadians behind the wheel. For a while retail leasing did the job. At its peak, one in two non-fleet vehicles in Canadian driveways was leased.

Leasing collapsed in the 2008 financial crisis but banks and auto finance companies looking to sustain sales volumes noticed something interesting. When the average 48-month lease ran out, most people bought the vehicle they’d leased and promptly financed it for another two or three years. That suggested a tolerance to borrow over six or more years for a car. The long-term loan was born.

“Then it took off,” said DesRosiers. “Then it’s all about monthly payments.”

The improved quality of vehicles also made long-term loans more palatable. Cars now can be trouble-free for eight to 10 years with proper maintenance and not junked for 15 years or more. The odds of paying off the loan before the car goes to the crusher are pretty good.

But Prymak said rationalizing a long-term loan is not the same as concluding it’s a good idea. For example, those lower payments tempt people into buying more expensive cars than they otherwise would, or should.

“If you can buy a $30,000 car over 84 months, you’re more likely to do that than buy a $20,000 car over 60 months,” he said. “That’s one of the biggest problems that we discovered.”

Prymak said he found many examples of people who for whatever reason traded in their vehicles before the loan was paid off and had to roll over the outstanding balance into a new loan, adding to their debt burden.

The problem is exacerbated for those who qualify only for subprime loans and risk getting into a serious financial hole, he said.

Depreciation eats into car owner’s equity

The report quotes Michael Rothe of the Ontario Motor Vehicle Industry Council, the industry regulator, saying people trade their vehicles on average every four years. With most depreciation occurring in the first four to six years of a car’s life, it means many buyers have negative equity when they trade in their financed car.

But DesRosiers said his own data shows the average length of new-car ownership now is between seven and nine years, more than enough time to pay off the loan. Most people are technically upside down on their car loans at some point, he said, but it’s irrelevant as long as they keep it.

True, some people may trade in early because of changed family circumstances, such as adding children, he said. Otherwise, owners wait until their vehicle becomes unreliable or too expensive to repair.

For others, well, “if they’re dumb enough to trade their vehicle in two or three years [early] because they get what I call a new-car erection, then serves them right.”

If there are problems, they may be more connected with the subprime segment, DesRosiers said. Most of those buyers, though, purchase used vehicles that cost less and usually involve financing for shorter terms.

The average transaction price for a new car last year was $37,697, up about $10,000 from 2012, according to DesRosiers’ data. By contrast, used vehicles averaged $12,851, with many below $5,000.

Many who buy at the lower end have trouble getting conventional financing and resort to subprime loans from banks or private lenders. They’re the people who Prymak believes are most vulnerable.

DesRosiers said subprime accounts for 17 per cent of used car loans (versus six per cent for new vehicles). The low transaction cost of those vehicles means buyers are less likely to get into deep trouble based on the car loan itself, he contended.

Car loan default rate remains low

The overall default rate on all vehicle loans is less than one half of one per cent, DesRosiers said.

Concern over subprime risk to some extent reflects the U.S. experience, he added. Despite the 2008 housing collapse fueled by subprime mortgages, American lenders remain addicted to luring the less creditworthy into borrowing money. That goes for cars, too.

“They are the bottom quartile, the dregs of the economy, the unemployed, the indigent, the kids who have minimum-wage jobs,” DesRosiers said. “That is the core subprime market.”

In Canada, most subprime lending is through a couple of the big banks, which control some auto-financing arms. They are far less likely to approve car loans that routinely get rubber-stamped in the U.S. Those people wind up not buying a car at all, he said.

Prymak concedes the problem is not as big as in the United States but still believes it should be addressed.

“We need more education, especially when it comes to educating consumers about these types of loans before they go to the dealership,” he said. “They go into the dealership without knowing any of these things and they sign a contract and boom, they’re in trouble.”