Car loans are a lurking problem

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If you’re an elected official in Ottawa, you’ve got your pick of pressing economic files to fret about.

Inflation. Housing. Groceries. Deficits.

There’s so much on the plate, in fact, that Conservative MP Michelle Rempel Garner is worried there’s a threat to the country’s financial well-being that is going almost unnoticed. In fact, she says, she’s losing sleep over it.

Ms. Rempel Garner fears that car loans are the next big financial pileup waiting to happen. She’s been saying so for months. Nobody seems to be listening.

“It has been like pulling teeth to get on the radar in Ottawa,” she said.

Ms. Rempel Garner, a former cabinet minister in Stephen Harper’s government, had been troubled by what she was seeing in car loans for months when she wrote a piece on Substack in January, warning that auto debt could become the source of Canada’s next financial crisis.

“Partisan hat off, MP hat off, this looks really frothy – and problematic,” she said in an interview this week. “I don’t feel like it’s been treated as a front-burner issue. But it does have the potential, I think, to create a large degree of instability, putting it mildly.”

The scale of the threat is certainly debatable. Auto loans account for less than four per cent of Canadian household debt. Mortgages, on the other hand, command roughly three-quarters of that debt. Naturally, policy makers and economists have focused their attention on the mortgage segment when looking at financial risks.

Still, car loans represent more than $100-billion of outstanding debt – and the problems brewing for those loans are potentially serious. There’s no question that the landscape for financing a car purchase has grown much more treacherous since the pandemic. And unlike the mortgage segment, car loans lack the regulatory safeguards designed to protect consumers from taking on debt that exposes them to too much financial risk.

The average price for a new vehicle in Canada topped $66,000 this year, up almost 50 per cent in just four years. The average payment on a new car loan today is approaching $900 a month.

Almost 60 per cent of new loans have terms of seven years or longer. Fifteen years ago, less than 10 per cent had such terms – four- and five-year loans were the norm.

In short, financing a new vehicle has become more like taking out a mini mortgage. But unlike a house or condo, a car or truck is not an asset that appreciates in value while you’re paying it off; it’s a good that depreciates in value every day.

Another potentially troublesome difference, Ms. Rempel Garner suggests, is the lack of “guardrails” limiting the amount of auto debt that already debt-burdened Canadians can take on. In the mortgage market, the government has imposed stress tests that effectively limit the size of a mortgage to what a borrower could afford even if the interest rate on the loan were significantly higher than the prevailing rate. No such limit exists on car loans – despite the substantial increases in both size and terms, which have, effectively, increased the risks and uncertainties for both lenders and borrowers.

We may be seeing the consequences beginning to emerge as interest rates have continued to climb to new heights this year. Borrowers are starting to crack. The share of car loans “in arrears” – defined as being more than 90 days behind in payments – has been climbing steadily since mid-2021 and is now higher than at any time in the past 15 years.

While it’s hardly a staggering number – a slim 0.57 per cent of all car loans, according to statistics compiled by the Bank of Canada – it nevertheless indicates growing strains on indebted households. When you consider that many of those households will have to renew their mortgages in the next couple of years, at much higher interest rates, car payments may well face even greater pressures.

The combination of long loan terms and depreciation causes another problem for both borrowers and lenders. Increasingly, the outstanding balance of the loan is greater than the resale value of the vehicle – a condition known as “negative equity.” Even financially healthy borrowers face the increasing likelihood that when they trade in their used car, they will still owe more than the trade-in value – leaving a debt hangover on their next purchase.

Yet none of this is receiving much attention from either the federal government or, for that matter, Ms. Rempel Garner’s own Conservative colleagues in opposition. With the focus of the political debate around the economy focused very much on housing and food inflation, Ottawa is suffering from “a lack of bandwidth” to address other simmering economic threats.

“There are a lot of other issues that the government just isn’t focusing its attention on right now,” she said.

She argues that the government needs to wake up to the issue and, at the very least, conduct some serious public analysis of the car loan market. It needs to get on top of the situation before these simmering problems come to a boil.

“We can’t be in a position where we’re reacting to an implosion after the fact.”