The trend to longer car loans is starting to ring alarm bells in Canada's auto industry.
Loans of longer than six years have shot up to 57 per cent of new vehicle loans in Canada this year amid fierce competition by auto makers offering low-interest rate incentives and consumers anxious to keep their monthly car payments as low as possible.
But the longer terms are causing problems at dealerships as drivers shop for new cars and discover their vehicles have so-called negative equity, where the amounts remaining on their loans exceed the value of the vehicles they're trading in, dealers and senior executives in the auto financing business told a conference Wednesday.
"Negative equity has become an epidemic," said Robert Varga, president of Walkaway Canada Inc., which offers insurance to car buyers worried about losing their jobs or becoming disabled and thus having to give up a vehicle they have financed.
The concern about the length of loans comes amid a spurt of automotive debt – even as Bank of Canada Governor Mark Carney and others urge Canadians to rein in household debt before interest rates rise from their current record low levels.
Ron Loveys, who owns Whiteoak Ford Lincoln in Mississauga, offered an example of how longer-term loans are increasingly playing out in dealerships.
A young family arrives looking to trade in a three or four-year-old Focus compact for a larger Escape or Edge crossover utility vehicle.
But they discover the amount remaining to be paid on the Focus is more than it's worth, and the difference has to be blended into the monthly payments on the new vehicle. That can boost those payments by as much as $300.
"They panic," Mr. Loveys said. "They get upset at the dealer, at the vehicle, at the brand. Long-term financing is not the way to go."
About 30 per cent of vehicles were in a negative equity position at trade-in as of the end of October, according to data compiled by consulting firm J.D. Power and Associates, one of the sponsors of the conference.
Loan durations have increased sharply in recent years. The firm's data show that loans of six years or longer represented slightly above 10 per cent of the market in 2007, but more than doubled in 2008 as auto leasing dried up overnight during the credit crisis and recession.
The issue of leasing is crucial in this debate, noted Dennis DesRosiers, president of DesRosiers Automotive Consultants Inc.
Auto makers, Mr. DesRosiers said, began stretching loan payments to compete with banks, which entered the market with long-term loans as a way to increase their auto financing business after dealers successfully lobbied the federal government to prohibit the banks from getting into auto leasing.
Long-term loans should not create a problem, he said, because new car buyers hang on to their cars for an average of more than nine years currently and the default rate on auto loans is considerably less than 1 per cent.
Mr. Loveys said he prefers leasing as a way to keep monthly payments low.
Automotive debt, meanwhile, is soaring. It rose 11.25 per cent to average of $19,228 in the third quarter in Canada from a year earlier, while credit card and other loan debt fell, according to consulting firm TransUnion, which analyzes credit trends.
Lengthening the terms of loans is helping boost auto sales this year, Bank of Montreal deputy chief economist Douglas Porter noted.
"And these loans basically are for a consumer good, admittedly a relatively long-lived one," Mr. Porter said. "But unlike a home, the borrower's asset won't have much value a decade from now."
He said he as not heard public concern from the Bank of Canada about auto loans specifically, "but if it isn't on their radar, it soon will be."