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OMVIC Blog: Car Buying Tips

Negative Equity: A Car-Buying Contradiction

Jan 24

Written by: OMVIC Communications
Thursday, January 24, 2019  RssIcon

Negative Equity: A Car-Buying Contradiction

Friday, January 25th is “Opposite Day.” We’re not sure who invented this special day, but we think it must be the same committee who decreed May 24th “National Scavenger Hunt Day” or August 12th“Middle Child Day.”

There seems to be no real consensus on how to celebrate Opposite Day – some eat breakfast for dinner or wear their clothes backwards. For OMVIC, Opposite Day is the perfect time to talk about negative equity, an expression that reveals itself to be contradictory. Negative Equity, just like “jumbo shrimp” and “confirmed rumour”, is an oxymoron.

 

negative equity

Defining Negative Equity;

Negative equity actually means that you owe more for a car than what it’s worth. It becomes an issue when you want to trade in that car you still owe money on.   Here’s an example: Timmy buys a car for $30,000 and finances it for 96 months (eight years). Timmy’s a commuter who drives 35K kms year. After four years his car has been driven 140Ks and it’s out of warranty, so he decides it’s time to trade it in on a new vehicle that costs $30,000. Because of depreciation (made worse by the high mileage), Timmy’s trade-in is worth $8,000 wholesale – but because of his eight-year loan, he still owes $16,500. Timmy is waist-high in negative equity, to the tune of $8,500. That means to buy a new car he must borrow $38,500. $30,000 (for the new car) AND    $8,500 (to pay off her trade’s negative equity). Timmy owes nearly $40,000 for a $30,000 vehicle – a vehicle that began depreciating as soon as he took delivery. This scenario will lead to higher monthly payments for Timmy. Just imagine what will happen when Timmy goes through the same process four years down the road. It’s a borrowing technique with potentially disastrous results.

How do Consumers get into Negative Equity?

Because of the lure of extended term loans, consumers can easily fall into negative equity. Car-buyers can purchase the vehicle of their dreams, with no money down, for a monthly, bi-weekly, weekly (or even daily) payment that seems affordable. We know cars aren’t getting any cheaper and most of us aren’t significantly wealthier so how is this happening?  Terry O’Keefe, OMVIC’s Director of Communications and Education, explains: “For many, this is a direct result of historic low-interest rates combined with longer repayment terms of 84-96 months. Traditionally, four to five-year car loans were the norm. Today, it’s common for consumers to finance their vehicle over seven to eight years which is a significant length of time for a product that begins depreciating the second you drive it off the lot.”

Questions to ask yourself when considering a long-term loan

1)How much I drive?
2)How long do I intend to keep the vehicle?
3)How quickly will the car I want to buy will depreciate? 
4)What is my own creditworthiness?

Three common ways to lessen or avoid negative equity

    1)Make a sizeable cash downpayment when purchasing a vehicle
    2)Make extra payments for the duration of the loan
    3)Don’t trade in or sell the vehicle until it is paid off

    The Bottom Line

    Opposite Day will be over Friday, January 25th at midnight, unfortunately, negative equity won’t disappear at the stroke of midnight. It could take seven years or longer. Despite its potential pitfalls, we are not saying that car-buyers shouldn’t take long term loans, quite the opposite, in fact! According to O’Keefe, consumers just need to be smart and upfront with themselves about what kind of car owners they will be. Says O’Keefe: “They need to educate themselves and really be honest about their needs, car-buying habits and the amount of risk they’re willing to take.”


    About OMVIC

    An educated and informed consumer is a protected consumer. Visit omvic.ca o learn more about your car-buying rights and when they apply, as well as additional tips on buying a car in Ontario.

     

     

     

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