Warning on Canadian auto finance market

The Financial Consumer Agency of Canada (FCAC) is warning that consumers should think carefully about how they finance car purchases, after a research report highlighted a growth in long-term car loans of more than six years, prompting fears of problems in the auto finance sector.

The agency says because long-term car loans feature lower monthly payments, consumers are increasingly comfortable buying “more car” than they may be able to afford in the long term.

Making car payments over terms of 72, 84 or even 96 months (six to eight years) is costly for borrowers who must pay interest for a longer period of time than would otherwise have been the case for shorter, more traditional loans, typically 60 months or five years. In addition, long-term loans are especially expensive for consumers with low credit scores, who may be subject to higher interest rates.

To add to this, many consumers continue buying new cars before their existing loans are fully repaid. In these circumstances, consumers put themselves in the position of having to roll the debt owing on the long-term loan into the loan for the purchase of the new vehicle, thereby potentially stepping onto an “auto-debt treadmill,” the FCAC says.

FCAC is addressing these concerns by focusing its oversight and education efforts on this market. It is ensuring that federally regulated financial institutions’ indirect lending activities, including auto loans, comply with federal legislative and regulatory requirements.

FCAC has also developed new online material to help consumers navigate the complexities of financing a car, understand the importance of shopping around and budgeting, and make informed decisions.

Survey findings

The survey found that Canada’s auto finance market has nearly doubled in the last eight years.

In 2015, the average new car loan had a term longer than 72 months, up from approximately 65 months in 2010. Long-term car loans constitute approximately 60% of the car loan portfolios of Canada’s largest financial institutions.

Despite opting for long-term car loans, many consumers continue to change their vehicles every four years or so, while still owing on their previous vehicle.

Total transaction costs for new vehicles are rising more than twice as fast as average monthly payments, as a result of longer average loan terms.

The percentage of consumers in negative equity positions trading their cars has risen 50% over the past five years: from 20% in 2010 to 30% in 2015.

Caution

Lucie Tedesco, FCAC Commissioner, said: “Recent trends in extended-term car loans have raised several concerns. Consumers must carefully examine their needs and their financial situation to ensure they can repay their car loans without undue strain, and with a full appreciation of the total interest charges and value of the car throughout the loan period.”

“Consumers and auto dealers tend to focus on the monthly loan payments required for a car purchase. Few take issues such as negative equity into account when choosing between different car loan terms. This is one of the reasons why FCAC will work with stakeholders to make sure that consumers are getting enough information and know which questions to ask.”