The Bank of Canada is raising a caution flag over growing auto debt among Canadian consumers, noting that auto loans have almost doubled in eight years to more than $120-billion amid growth that has outpaced other forms of household debt.
The central bank added its voice Wednesday to a growing chorus of consumer advocacy groups, analysts, bankers and even some senior auto industry executives expressing concern about long-term auto loans that are helping fuel record vehicle sales in Canada.
The bank said in its Financial System Review that it has "modest concerns" about the rise in auto debt, but "the recent changes in the auto financing landscape warrant continued monitoring in the context of already high household indebtedness, particularly if the debt is being incurred by borrowers who are already stretched financially."
The bank said two factors are being watched closely: the growth of loans to people with low credit rising to 25 per cent of the market, and risky practices such as longer term loans and loans that are becoming a higher percentage of the total value of a vehicle.
The growth of longer-term car loans that stretch as long as eight years has helped propel the Canadian market to record sales that are expected to top 1.8 million vehicles this year, but some auto makers are trying to encourage buyers to take shorter terms or lease vehicles instead of buying them.
The longer the term of the loan, the lower the monthly payment, which is the key element in consumers' minds as they consider new vehicle purchases.
But the danger to consumers is that if they want to trade in their vehicles before the loan has been paid, they can find that the vehicle is worth less than the amount of money remaining on the loan.
If they buy a new car, "now you've got yourself a loan on a new car, plus the residual balance on the old car and [you're] putting yourself in worse financial shape," said Scott Hannah, chief executive officer of Credit Counselling Society in Vancouver.
Mr. Hannah's concern is echoed privately by some dealers.
"It could be a young couple buying their first car and we tell them, 'You've got to think about three or four years from now, your life may change … and a subcompact just isn't going to cut it,'" said one Toronto-area dealer. "Consumer satisfaction goes down the drain. They get mad at us, they get mad at the vehicle, they get made at the brand."
Mr. Hannah is worried about the impact long-term car loans with fixed payments will have on the ability of consumers to pay mortgages and other debt "when interest rates rise, not a question of if, but when."
Many Canadian economists expect rates to begin rising during the fourth quarter of 2015.
"If you've already got a large vehicle loan factored in – that may have a term that is going to expire in three or four years – you're going to be in a worse position to deal with the rise in interest rates than a person who has been very careful in paying down their consumer debt," he said.
The average length of an auto loan stands at about 74 months, compared with 63 months in 2009, according to data compiled by consulting firm J.D. Power and Associates. The firm said 69 per cent of loans now exceed six years.
Part of the reason for that growth is the drop in vehicle leasing, which made up almost 50 per cent of the Canadian market before the 2008-09 recession. Some vehicle companies eliminated leasing entirely during the recession. It has returned but now represents about 20 per cent of the market.
Monthly payments, meanwhile, have grown since 2009 by just $20 to $542 this year. Transaction prices, minus cash rebates, have jumped to $31,389 this year from $26,774 five years ago, said Robert Karwel, senior manager of the Power Information Network in the consulting firm's Canadian office.