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While alarms ring about debt in Canada, changes in the way Canadians finance their car purchases are fuelling a debate about whether the auto loan business needs to be restructured.
Loans that drivers are taking out to buy new vehicles are growing much faster than inflation and gross domestic product, jumping 13 per cent in the fourth quarter of 2014 from a year earlier. The Bank of Canada raised a caution flag last December about auto debt generally, and fretted that the terms of loans might be growing too long.
That concern stems from a drastic change in how drivers finance car purchases. Before the 2008-09 recession, leasing represented nearly half the new vehicle financing market in Canada.
When the credit crunch wiped out leasing, lenders moved in with loans as long as eight years – including interest-free offerings – to address the No. 1 concern among most car buyers, which is to keep monthly payments as low as possible.
But the fear raised by the central bank and shared by some bankers, auto industry executives and even some dealers is that things have gotten out of hand.
"We're now starting to recognize that longer-term loans are not good for the industry, it's not good for the consumer and it's not good for anyone," Ray O'Kane, managing director and head of national dealer finance for Bank of Montreal said in an interview. "An awful lot of customers that have a really good credit rating in my mind are making ill-informed or poorly informed financial decisions."
Auto debt has grown as auto makers revel in what is the best of times for the Canadian market. Vehicle sales topped a 10-year-old record in 2013, broke that record last year and were 4 per cent higher than the 2014 pace through the first four months of this year.
Loans of six years or longer are helping to fuel those sales. They accounted for 66 per cent of auto loans in April, which was down from a recent peak of 69 per cent in August, 2014, according to data compiled by consulting firm J.D. Power and Associates.
Mr. O'Kane's worry is that even though vehicles are more durable than ever, the technology in them is changing so quickly that drivers will want to trade them in long before the term of the loan is complete and the vehicles paid off.
"Somebody has a two- or three-year-old car and their neighbour gets a new car – all of a sudden their car feels old," he said.
But if the owner of the older car is only two years into paying off a seven-year loan, he could find the amount remaining on the loan is more than the car he's trading in is worth.
Mr. O'Kane believes dealers and lenders should make sure consumers are aware that a five-year loan will cost less than an eight-year loan even though the monthly payments are higher on shorter-term financing.
"If after three to four years you get disillusioned with the car, you have built up some equity and you can turn it," he noted. "The problem I'm having is we're not having these conversations with the consumers."
Industry analyst Dennis DesRosiers is a firm believer that concerns about auto debt and long-term loans are overblown. If drivers plan to hang on to their vehicles for six, seven or eight years, there's nothing wrong with financing them over those same periods, Mr. DesRosiers said.
"What the vehicle companies worry about is longer amortizations lead to longer ownership cycles," he said. "I think it's the exact opposite. Because we have a longer ownership cycle, we have longer amortizations."
He noted that leasing has bounced back from the low levels it hit during the recession to about 25 per cent of the market.
The return of leasing helps, Mr. O'Kane said, but he added that consumers need to realize that a lease is effectively a long-term rental, they can be liable for wear and tear and are subject to penalties if they exceed the annual kilometre limits.
Consumers need to be as well-educated on what he calls the "back end" of a car purchase as they are when they walk into a dealership fully armed with knowledge about the features of the vehicles on display, he said.
"I've asked my team here to talk about how we can talk to the dealers, but we're leaving it up to them to have that conservation [with buyers]," he said.
There's no doubt that people taking out auto loans or any kind of debt need to live within their means, said Jeff Schwartz, executive director of Consolidated Credit Counseling Services of Canada Inc.
"As consumers, we have to be fiscally responsible," Mr. Schwartz said. "We have to look and say, 'what can we truly afford?' Just because somebody is willing to give it to us doesn't necessarily mean we can afford it."
Brian Moynihan found that out the hard way. Through a series of trade-ins, the 61-year-old Vancouver retiree found himself owing $43,000 last year on a pickup truck. Then his pension was cut and his income fell from $4,000 a month to $3,100.
He was paying $580 a month on the truck plus insurance, so he gave it up and now he doesn't own a vehicle. He is in the process of moving in with a friend to reduce his rent and help pay off other debts.
"I should not be in the position I'm in, but I am," he said. "That's my doing."
The pension didn't help, he acknowledged, but he plans to be debt-free in a couple of years.