Nov 8

Friday, November 8, 2019 

 

There are some things which should last forever, like love, or a diamond ring, but a car payment is not one of them. Yet forever is how long it might feel if you take out an extended-term loan (e.g. 96 months), without educating yourself on the perils of negative equity—owing more for a car than it is worth.To avoid the pitfalls of an extended-term loan, consumers need to educate themselves and be honest about their needs and car-buying habits.

Negative equity 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 his 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 depreciate? 

4) What is my creditworthiness?

Three common ways to lessen or avoid negative equity

1) Make a sizable cash down payment 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

About OMVIC

As the regulator of motor vehicle sales in Ontario, OMVIC’s mandate is to maintain a fair and informed marketplace by protecting the rights of consumers, enhancing industry professionalism and ensuring fair, honest and open competition for registered motor vehicle dealers. Visit omvic.ca to learn more about your car-buying rights as well as additional tips for buying a car in Ontario. For car buying tips, check out the OMVIC Academy. You can view other resources such as multilingual videos and download the OMVIC Car-buying Guide.

 

 

 

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