Canada’s Financial Consumer Agency Warns about Long-Term Loans

Canada’s Financial Consumer Agency Warns about Long-Term Loans

Long-term

Consumers have a number of options when it comes to automotive financing. They can opt, of course, to pay cash for a car up front.. Many folks shopping for the best financing deal choose to keep interest payments down by short-term high-monthly-payment loans. And then there’s the long-term loan.
Taking out a car loan with monthly payments so low that the vehicle doesn’t get paid off for six to eight years – in some cases the lifetime of the car – is an option that appeals to folks with a lot of demands on a limited monthly income. But according to recent data released by the Financial Consumer Agency of Canada, the long-term option has serious drawbacks for both borrower and lender.
Long-term financing has been growing among Canadian car buyers since 2010. But with this growth have emerged some serious problems.
One of the most serious of these problems is that of negative equity, a concept that has become all too familiar in automotive finance news since the financial crisis of 2008. When a consumer owes more on an asset than that asset is worth, negative equity ensues. And it becomes a headache when the asset is the automobile that the consumer is offering a car dealer as a trade-in.
About 30% of cars offered as trade-ins by Canadian consumers arrive at the dealership with negative equity. The primary cause is that the consumer either wants or needs to replace the vehicle before it’s been paid off.
The amount of money still owed on the trade-in gets “rolled in” to the new long-term loan, meaning it will take the consumer even longer to pay off the automobile. And the ensuing burden isn’t just the financial strain upon the consumer; the dealer too has to fuss with added paperwork and stress over the viability of the loan.
The FCAC’s recent report, both customer and dealer need to be more savvy about the problems with long-term loans. If the customer understands the drawbacks to a lengthy loan (with or without negative equity rolled in), he or she is more likely to give serious thought to its viability. And if dealers recognize that long-term loans may put at risk the clients the loyalty of long-term clients, they may become more careful about scrutinizing the ability of customers to pay them off.
At the heart of the issue is the reason why the long-term loan is sought in the first place. If the customer simply cannot manage higher payments each month, the question arises, will he or she be able to cover maintenance and insurance costs on the vehicle? Answering such questions may require that the customer do some serious budgetary scrutiny. And if the customer can financially manage higher payments each month, the dealer should make a real effort to inform about the money saved in interest when such a short-term loan is accepted.
The FCAC has also used its report to announce its intention to take a more active interest in how consumers can keep track of negative equity, by asking banks and credit unions to disclose data on negative equity along with other financial information.
For Canadian car buyers in general, the automotive news is good when it comes to default rates for auto loans: they are down for the country as a whole. But Western Canada needs to be cautious about long-term auto loans. The FCAC has reported a recent increase in defaults on long-term auto loans in British Columbia and Alberta.