The second post in our ongoing Financial Literacy Series for Financial Literacy Month is about negative equity. We answer what you can do to protect yourself against it, how to identify it, and what comes next.

What is Negative Equity in a Car Loan?

The answer to this question is very succinct: Negative equity means owing more for a car than what it’s worth. How you get into negative equity is more complex.

How to Get into Negative Equity

Let's say you decide to buy a car you really like. If you take out a three-year loan, the monthly payments will be very high. If you take out an extended-term loan lasting between six and nine years, the monthly payments become more affordable. However, by the time you pay off your loan, your car’s value will depreciate significantly. If you plan to keep your vehicle for a long time, depreciation may not be a problem. Over time, your needs may change since you made your purchase. You may want to trade it in for another car before you’ve finished paying off the loan, resulting in heavy additional costs. Let’s take a closer look.

Vehicles that would have been completely unaffordable two decades ago are now financially accessible. Many consumers can buy the car of their dreams, with no money down, for a monthly, bi-weekly (or even daily) payment that has somehow become “affordable.” But how? Did cars get cheaper? Are we all significantly wealthier? Or is something else at play?

 

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.

The majority of consumers borrow money for a vehicle purchase. Some choose to use a personal line of credit or arrange financing at their bank or credit union, but many have the dealer arrange the financing. This often makes sense—dealers have access to numerous lenders that may provide terms or rates unavailable elsewhere. But this doesn’t mean consumers shouldn’t carefully consider what is being offered and take steps to ensure they are getting the best possible finance rate and terms.

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 24^th “National Scavenger Hunt Day” or August 12^th “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.

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.   

Vehicles that would have been completely unaffordable two decades ago are now financially accessible. Many consumers can buy the car of their dreams, with no money down, for a monthly, bi-weekly (or even daily) payment that has somehow become “affordable.” But how? Did cars get cheaper? Are we all significantly wealthier? Or is something else at play?

When you owe more for a car than what it's worth, you have negative equity. Follow our infographic to find out how easily it can happen.

Ontario’s vehicle sales regulator is providing educational information and tips to consumers who are financing their next car-purchase. “Traditionally the most common source of complaints received by OMVIC relate to vehicle condition or contract cancellation” explained John Carmichael, OMVIC CEO and Registrar. “However we are noticing an increase in complaints specific to finance agreements; and in the past few years, this has led to a number of dealers facing charges or licence revocation.”

Making car-buying decisions based solely on a low monthly payment could be financially hazardous and is becoming a problematic trend amongst many consumers. When buying a car it’s important consumers are aware of the potential consequences of financing vehicles over extended terms (e.g. 84-96 months). In some instances, particularly if the consumer has bruised credit and therefore only qualifies for a high interest loan, stretching the repayment term out can result in paying more in interest than the actual purchase price of the vehicle. Consumers should ensure they are getting the finance terms they want and can afford.

There’s a growing trend amongst some consumers that may have unexpected financial consequences ‘down the road’. Known as Monthly Payment Junkies, these consumers ignore the potential pitfalls of financing a vehicle over an extended term such as 84-96 months and make their car-purchase decision based solely on a low monthly payment.