A new report from consumer watchdog group Financial Consumer Agency of Canada (FCAC) draws attention to the troublesome trend for borrowers to take out car loans with extended terms (i.e. six years or more).
Some quick facts from the report:
- In 2015, the average new car loan had a term longer than 72 months, up from approximately 65 months in 2010.
- Although Canadians favour long-term car loans, they still change their cars approximately every four years, with a balance remaining on their car loan. That loan balance (and all of that interest) rolls into the new loan.
- Negative equity (owing more than you own) for consumers trading in their cars has jumped 50 percent in the last five years, up from 20 percent in 2010 to 30 percent in 2015.
“Long term loans feature lower monthly payments, yes- but also end up charging significantly more in interest over the term of the loan. Consumers are fooled into thinking that they can afford the car because of the low monthly payments, but fail to take into account the long term effects of these huge interest charges,” says Jeff Schwartz, executive director at the Consolidated Credit Counseling Services of Canada.
“Also, when you consider that so many people are carrying ongoing car loan balances, they are accumulating interest on top of interest. It creates a vicious cycle that never really lets consumers get ahead of their debt.”
When car shopping, you’ve got to remember that you are not only buying a car, but that you are possibly entering into a financing agreement which could have some serious financial implications down the road.
Do the math
Auto dealers tend to focus on the monthly payment, which is very attractive on the surface. But can you really afford it? Think about it. Instead of taking that balance and paying it off, you’re extending it out with more interest over more months. It’s more money out of your pocket, pure and simple.
Don’t forget that cars are depreciating assets, so their value will drop substantially over time. If you enter into long term financing, you are increasing the chance of owing more than you own by a long shot.
Adjust your payments
If you are like most consumers and plan to trade your car in after four years, then you should adjust your payments to suit that timeline. Yes, your payments will go up if you shorten your term to 48 months, but you’ll also erase your car debt before you take on more. You’ll also have a more sensible timeline against the car’s asset value.
You have a few options to reduce your debt when buying a car. You could always wait and save for a larger down payment, which means that you’ll borrow less and own more of the car. Borrowing less means saving on interest charges as well- which will mean more money for other expenses (like maybe gas and car insurance).
Buying used is a good option to save money. If you buy a car that is even only a couple of years old, you can get a lot of the same features, but save a large amount off of the sticker price.
Do you find yourself taking on more debt than you can handle- to finance your car, or maybe for other purchases? The first step to stopping the debt cycle is to take control. We can help. Call one of our trained credit counsellors or check out our free online debt analysis tool to get started.