Your auto loan payment may be way too high. Here’s What’s Happening – National

George Iny recalled a woman who wrote saying she was paying around $550 a month for her new 2018 Toyota Corolla on a seven-year loan.

“It doesn’t show up anywhere in anyone’s stats, but obviously her family is hurting because they’re paying $250 a month too much for that car,” said Iny, who heads the Automobile Protection Agency (APA ), a consumer advocacy group.

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Perhaps the most egregious example he has ever seen of an inflated car loan is that of a man who owed nearly $100,000 on a Chevrolet Volt, an electric car.

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You see people like that, not every day, but of course every week. »

Behind the gargantuan loans are increasingly long auto loans, early swaps and negative equity, a problem long known to insiders but still misunderstood by many consumers, according to Iny.

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Negative equity

What is “negative equity?” you might be wondering.

This means that the market value of everything you bought has fallen below the outstanding balance of the loan you took out to buy it.

In real estate, it’s called “being underwater” and it’s a relatively rare occurrence. House prices typically go up year over year, so it usually takes a housing downturn for homeowners to find themselves underwater (think what happened in the US after the 2007 housing crisis) . Negative home equity can be a headache because during a recession it can force you to stay in an area where there are no jobs instead of moving to where there are more. of opportunities. You’re stuck because you’d lose money – potentially a lot – if you sold the house.

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For cars, on the other hand, it is different. Unlike houses, vehicles to lose value over time, which means that unless you’ve put down a large down payment, you’ll likely owe more on your new car than the vehicle is worth, at least initially.

Vehicles typically lose about a third of their value within the first year of ownership, said Brian Murphy, vice president of data and analytics at Canadian Black Book. The good news is that the rate at which vehicles lose value slows significantly after the first year. Since your car loan repayment rate remains constant, this means that you will eventually catch up and start owing less than the value of your four-wheeler, known as positive equity. .

However, the smaller your down payment – ​​if any – and the longer your loan term, the longer it will take you to get there.

Henry Gomez/Global News.

Henry Gomez/Global News

The problem of negative equity arises when you trade in your vehicle before it’s fully paid off, which is increasingly common among car buyers in Canada.

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Let’s say you bought a compact SUV for $35,000 with an eight-year loan and zero down payment. It may take you six years to reach the point where your vehicle is worth more than the balance you owe it. If you decided to trade it after three years, for example, you would still be in the red at $5,800, according to an example provided by Canadian Black Book.

Now imagine you’ve taken your eyes off a new $40,000 vehicle. In order to fund this, the lender would incorporate your old balance of $5,800 into the new loan, for a total debt of $45,800.

If you started with a shorter loan but always traded with negative equity, your lender may be able to keep your debt repayment roughly stable by offering a longer loan, Iny said. Although the impact on your cash flow may be minimal, your debt load increases.

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This is how cars lead Canadians into a spiraling cycle of debt, according to Iny.

“Eultimately you’ll be asking for too large a loan relative to the asset you’re buying,” Murphy said.

And that’s where, he added, the bank will say “no.”

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The financial crisis, low interest rates and aggressive marketing

Borrowing to buy a car wasn’t so dangerous when the longest car loan you could get was five years, Iny said. The problems started after the 2008 financial crisis, when many automakers started offering terms of up to eight years.

Amid a weak economy and stalled sales, “tThe feeling was that if they could keep the payment low enough in a low interest rate environment, they would be able to get people in the door,” Iny said.

The strategy worked and the sector rebounded after a few years, Iny recalls.

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But the industry soon realized that seven or eight years was too long to see customers again. The solution, according to Iny, was to get car owners to trade in their vehicles before the end of the loan term, with the loan balance rolled into the new loan.

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To attract customers, the industry often resorts to aggressive marketing campaigns, according to Iny. Often, this involves an invitation by mail to come and discover the new models.

It’s like wine and cheese – something like a posh museum opening atmosphere,” Iny said. “But (they’ll tell you) ‘Look, for the same payment we could get you in a new car. Why would you want to keep that old one? You get Bluetooth, you get the rear view camera’.

For many, he said, the offer is “pretty irresistible”.

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But are longer car loans necessarily bad?

If you are not trading in your vehicle with negative equity, a longer term loan may be a good deal.

With a zero percent interest rate, a longer loan simply means lower monthly payments, theoretically freeing up money you could invest and earn a return.

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For anything above a zero percent rate, you’ll want to see how much more interest you’d pay with a longer loan. But if the interest rate is low, it may still be a good idea to opt for lower payments.

These are the “thoughtful” arguments Iny said he heard from financial planners.

In practice, however, he said, many people won’t invest a small amount of money they could save with a smaller car loan payment. They will simply use longer loan terms to keep their payments stable and buy more expensive cars.

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Still, one way to avoid negative equity, even with a longer loan, is to choose a vehicle that will hold its value better, Murphy said.

With a Toyota 4Runner, for example, someone with a seven-year loan of $54,000 would achieve positive equity after just four years because the midsize SUV depreciates remarkably slowly, he added.

In notes provided to Global News, Murphy compared the 4Runner to an unidentified similar vehicle that had a slightly lower price but a worse value retention history. Someone with a seven-year $52,000 loan for this SUV would have to wait almost six years before they could trade it in without negative equity.

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To help consumers assess their negative equity risk, Black Book provides an annual ranking of four-year models with the best held values. It also has an online loan calculator.

Still, longer loans carry greater risks, even if you choose a vehicle that will depreciate slowly or if you don’t plan to trade in early, Murphy warned.

Take car accidents, for example.

“If your car is written off and your insurance company says your car is worth $20,000, but you still owe $30,000, you can guess whose the difference is.”

The longer it takes you to reach a positive net worth, the more likely you are to find yourself liable for the balance owed on a vehicle written off as a total loss due to accident or theft.

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Some insurance policies offer the option of purchasing additional coverage to prevent this, said Anne Marie Thomas of However, this usually only extends for the first two years after purchase.

Beyond that, there’s something called gap insurance, which will cover some or all of your negative equity for a few more years, Thomas said.

Gap insurance might be worth it, Thomas said. But it’s still an added cost to your decision to buy a vehicle with little or no down payment and a longer loan term.

The crux of the problem, according to Iny, is that lenders are now making car loans worth far more than the market value of the vehicle they are supposed to be financing.

While car loans are often slightly more than the price of the vehicle, as they can also cover things like taxes and an extended warranty, until about 20 years ago the maximum someone would lend was 110 % of market value, according to Iny. On a $20,000 car, that would be $22,000.

Today, Iny said, “some…will let you fund up to $30,000 or $31,000.”

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