Lorraine Explains: Canadians need to smarten up when buying new cars
If you are a car owner, last week’s release of Canadian Black Book’s (CBB) annual roster revealing vehicles sporting best retained value at the four-year point is an important read. Everybody’s heard the expression ‘the second you drive a new car off the lot, the depreciation begins.’ Armed with information like that, sourced and compiled by CBB helps consumers know what to reasonably expect their vehicle to be worth.
That information matters for those considering selling their car at some point in the future. But more importantly, it also allows consumers to decide how much to finance if they need a loan. The news release from CBB also shows, however, too many of us are more than willing to take on too much debt for our rides.
If you secure a loan to finance a vehicle, you’re familiar with the concept of “being underwater” on that purchase. You owe more than you could sell the car for; you stay in this position, making your monthly payments until you hit the magic sweet spot of level ground. Unfortunately, the CBB release also highlights a troubling number from JD Power: In Canada last year, 30 per cent of “vehicle trade-ins were in negative equity averaging -$7,051.” That means 30 per cent of car buyers never arrived at the sweet spot before shucking off their current vehicle and climbing into a new one. Instead of hitting the pause button and considering the financial hit and damage to their credit they are doing, they hit play and roll the outstanding amount into the new purchase.
“Negative equity — when a consumer owes more on an auto loan than the market value of the vehicle — is a growing issue for Canadians. This negative equity, which could equal thousands of dollars of additional debt, is often rolled into subsequent auto loans, essentially compounding personal debt, a major Canadian economic concern,” outlines CBB in the release.
If I told you, with a straight face, that my kid was 96-months-old instead of saying he was eight, you’d think I was nuts — and you’d be right. But this is the swirling weasel-speak of car sales regarding loan terms. Not that long ago, a five year term was pretty much the industry standard. After the recovery following the economic meltdown of 2008, car sales became strapped to a rocket that only now is starting to level off. A car for you, a car for you, a car for you — everybody gets a car. You not only want a new car, you not only need a new car, you deserve a new car.
Where previously, the trick had been to push those with limited budgets into leasing — “Is $600 a month too high? Watch while I magically make it $350!” — it was now to push them into longer loan terms. This is the snare for those who buy a car by the month, instead of as the entire significant purchase that it is. There are many who feel that using a long loan term, especially if it’s at a low or zero-per-cent interest rate, is an effective way to pay off a car. If these people are disciplined, it is. But let me be blunt: If the only way to get into the car you want is to take out an eight-year car loan because you can’t afford to buy it in five, you can’t afford the car. Buy a different car.
And now, the chickens are coming home to roost, in the form of buyers getting deep into the endless years of car payments — on a car that has lost its lustre and is usually out of warranty — and has larger repairs in the offing. The solution should be to maintain the car as if you still love it, pay it out, then sell it and move on. Instead, dealers are more than happy to offer you a get-out-of-your-old-car free card: Take the outstanding loan on that old car and just apply it to this new one. When they massage the numbers across — you guessed it — another long term loan, it can seem reasonable.
It’s not. It’s dangerous. The fact that 30 per cent of trade-ins are over $7,000 in the hole is a wake up call that shouldn’t be ignored. Too many people are not disciplined, buying too much car and too often. If Customer A is 7K in the red, and is coming in to buy a new car, he not only doesn’t have a down payment, he is bringing that debt into the equation like toilet paper stuck to his shoe. A salesperson helpfully adds that outstanding loan to the new car; let’s say the new purchase is $20,000. Customer A now owes $27,000 on a vehicle worth, as it rolls off the lot, significantly less than $20,000.
The Canadian Black Book roster is an excellent tool for determining just how big or small a hit the car you own, or are considering, might take. Hint: lots of Toyotas in the mix. But if you are hauling along negative equity, you are scrubbing off the benefits of that retained value in cases of even a “good” car, and torpedoing yourself with a lesser one.
It’s too easy. But placing all the blame with the sellers means too many consumers are easily led, unprepared and foolish. The worst case I’ve heard was a reader on their third rolled-over car loan with a combined negative equity approaching $30,000. The car they’d just purchased with this caboose of debt wasn’t worth close to what was owed.
Unlike mortgage rules, cars can be financed for up to 130 per cent of their cost — and in some cases, even more. A good example was the Dodge Caravan equipped with the Canada Value Package. It was tagged at $34,000, even though you could get it with incentives for $22,000. But you could access lending on 130 per cent of the original $34,000. Great place to tuck a lot of negative equity.
We saw this happen to the housing and mortgage market in the U.S. Now, it’s happening in the car market. Negative equity will wipe out everything you’ve worked for in the blink of an eye, so just be smarter, stick to shorter loan terms, pay them out and keep your car. And remember: A 96-month-old is in Grade 3.