House prices, mortgage balances, and debt-to-income ratios get all the headlines, but car loans have quietly emerged as one of the major risks to Canadians' household finances.
We've seen a concerted high-profile effort from Ottawa to limit the ability for Canadian home buyers to stretch themselves too thin, including limits for federally-regulated mortgages, increased minimum requirements for down payments on more expensive homes, and stress testing of applicants when qualifying for mortgages.
In the meantime, auto-loan amortizations have gone off the deep end. Nearly three-quarters – 72 per cent – of new-vehicle loans taken out in Canada last year were for six years or longer, according to market research company J.D. Power.
To get a sense how much new vehicle financing with amortizations of five years and under has dropped and how much so-called "super-amortized" new vehicle loans have risen, consider the following data from J.D. Power.
From 2011 to 2016, seven-year vehicle loans, as a share of all new-vehicle loans issued, jumped to 44 per cent from 31.7 per cent. Eight-year loans? They rose to more than 10 per cent from 2.2 per cent.
Conversely, the good ol' five-year car loan dropped in share to 18.7 per cent from 29.9 per cent.
The Financial Consumer Agency of Canada also released a report on trends in the auto finance market, in February of 2016. Among the alarming findings is the increased number of consumers trading in old cars with negative equity. That means that instead of getting a credit for the value of a trade-in to put towards their next car, they owe more than the car is worth.
It has become common to roll this negative equity into new vehicle loans, and buying a $30,000 car can now, for example, come with an initial loan balance of $35,000. In fact, the average amount of negative equity rolled over into a new car loan stood at $6,659 in 2016 according to Canadian data from J.D. Power. To clarify, that data only refers to those who are underwater at time of trade-in.
I'm a staunch believer that you shouldn't borrow to buy depreciating assets, such as cars. It used to be common sense that if you didn't have enough money to buy something that didn't retain its value, that was a sure sign that you couldn't afford it. And in spite of years of lacklustre economic and wage growth, we've seen four consecutive years of all-time vehicle sales records.
Indebted drivers whose current vehicles are on their last legs have a choice: continue on the treadmill of continuously financing every single car you'll ever own, or make a change.
Maybe that change should be a big one. Like buying one of the least expensive cars. If you don't have a large family, and often find yourself wondering why you're surrounded by vehicles where humans take up less than 10 per cent of the seating and storage space in rush hour traffic, go small. Really small.
The convenience factor of a small car is underappreciated. It's easier to find parking. They tend not to have a lot of grunt, so they consume less fuel. They are cheaper to insure. And the financial savings can change your life. The speed limit for them is the same as it is for a high-end vehicle.
Full disclosure: Nissan Canada invited me to drive a race-prepared version of their Nissan Micra, a car that has a starting MSRP of under $10,000, during a full blown race weekend, so I'm going to use the street version of that car as an example of how one could overhaul their finances, although you could consider any other small car.
The Micra is one of the least expensive new cars available on the market, starting at a paltry $9,988. After adding taxes and fees, and factoring in incentives, an Ontarian could drive it off the showroom floor for $11,713.
Using the average loan payment for a new vehicle in 2015, $570 a month, for one of the 44 per cent of new-car loans in 2016 that were for seven years, let's see how our cash flow would be affected if we only had to finance $11,713.
Simply matching the amortization of seven years would require a monthly payment, including tax, of $167. Factoring in insurance and fuel savings might save another $40 per month, for a total monthly savings of $443. That would free up $5,316 per year for each of those seven years, for a total of $37,212.
But what if we opted for the now unconventional three-year loan? Our monthly payment would be $349, and again factoring in the insurance and fuel savings, we end up freeing up $261 per month.
After the loan ends, if we took that $349 monthly payment and committed that to saving up for our next car purchase, and assuming we needed a new car every seven years, we would have socked away $16,752, enough to buy a more expensive car outright. We would have successfully jumped off that auto-loan treadmill, while having freed up money to accomplish other financial goals all the while.
The Micra is just one example of cars we could buy to achieve these kind of savings; there are several other makes of small cars on the market that deliver similar results, such as the Chevrolet Spark, Mitsubishi Mirage and Hyundai Accent.
Pie in the sky? Maybe. But you know what they say. If you want to achieve things you've never achieved before, you have to do things you've never done before.