Kelly Collins chose to stretch out the loan on her new red Dodge Journey for an extra year because she wanted lower monthly payments, an increasingly common practice in debt-laden Canada.
“They were really good about letting me customize,” said Collins, who opted to move beyond a five-year term after being given the option to speed repayment if she has extra cash.
The average term of a light-vehicle loan in Canada is 69 months, close to a peak of 72 months set in the third quarter of 2013, according to data from marketing information company J.D. Power. The borrowing adds to signs Canadians are continuing to buy big-ticket items and tuning out warnings about unsustainable debt growth.
Longer-term car loans are leaving Canadians in debt for a longer time, Dennis DesRosiers, president of DesRosiers Automotive Consultants in Richmond Hill, Ontario, said in a telephone interview. “On a 96-month loan it takes 80-plus months before you are back in the money,” he said.
Policy makers have called near-record consumer-debt levels the chief domestic risk to Canada’s economy. While Bank of Canada Governor Stephen Poloz says the ratio of household debt to income should stabilize around current levels, most of the government’s warnings, as well as its actions, have been directed at mortgage debt. The Finance Department has tightened rules around mortgage insurance in a bid to cool a housing market that the International Monetary Fund called “a key vulnerability.”
There’s been no similar government intervention in the auto market, where longer-term loans are fueling purchases, according to Equifax Canada Co. The credit-tracking company reported in March that auto credit demand rose 9 percent in the fourth quarter from a year earlier, with loans of longer than 72 months being the main impetus. Canadian car and light truck sales will rise to a record 1.77 million this year from 1.74 million last year according to Carlos Gomes, an economist specializing in the industry at Bank of Nova Scotia in Toronto.
Light trucks led unprecedented new-vehicle sales of 197,740 units in May, Statistics Canada said July 23, boosting retail sales to a record C$42.0 billion ($38.4 billion). About 37 cents of every retail dollar spent that month was car related, compared with about 31 cents in the U.S. The agency reports retail sales for June on Aug. 22 in Ottawa.
“Canadian consumers have been ‘holding the economic fort,’ as exports and business spending lag previous recoveries,” Peter Buchanan, an economist at CIBC World Markets in Toronto, wrote in a report previewing this week’s report. “While July saw a strong rebound in auto sales, their ability to do so indefinitely is doubtful.”
The Bank of Canada is counting on rising exports and business investment to take over from debt-supported consumer spending in leading the world’s 11th largest economy back to full output over the next two years.
Easy credit has also helped U.S. auto sales, which are on pace for the best year since 2006. Moody’s Investors Service analysts wrote in a January report that auto lending companies are lowering lending standards in an attempt to win market share.
The Justice Department has subpoenaed financing units, including GM’s and Santander Consumer USA, for documents related to debt underwritten and securitized by their subprime auto-lending businesses.
Newspaper ads over the past month feature offers of eight-year loans for some Hyundai Motor Co. Elantra models and seven-year terms on some Buicks from General Motors Co., which DesRosiers said was about twice the length of typical loans a decade ago. Manufacturers and lenders are catering to consumers like Collins who want low interest rates and longer repayment terms that cut their payments.
Collins said she bought her car three weeks ago with financing of about C$30,000. “I wanted to stretch it out,” she said of her loan, as it meant that “my payments were smaller.” Asked if she was worried about any extra risk from adding a year to her loan, she said using the option for accelerated payments may end up improving her credit score. “It makes my credit look good.”
Scott Hannah’s colleagues see people every day who run into trouble with easy loans. The president of the Credit Counselling Society, a non-profit consumer service, says 10 to 15 percent of the 30,000 people his company meets every year are receiving advice because of car loans.
While stretching the term of a zero-interest loan doesn’t add to the total borrowing cost, it delays the point where the vehicle’s worth becomes greater than the debt. Hannah also said long-duration loans can entice people into taking on more debt than they may be able to handle.
Hannah recommends consumers stick to a maximum length of five years and a 20 percent down payment on their car loans. “If you can’t put down 20 percent including taxes you aren’t ready to buy a car,” he said. “It’s not in the consumer’s best interest to take out a longer-term loan for a depreciating asset.”
There’s little evidence to date Canadians are struggling to keep up with their auto loans, with first-quarter delinquency rates of 0.76 percent over 60 days and 0.61 percent over 90 days both close to record lows, according to Equifax Canada.
“We don’t see any obvious red flags,” Regina Malina, a senior director at Equifax in Toronto, said in a telephone interview. “Whether we can relax and say there’s no problem, I’d say it’s too early to conclude.”
Gerry Cloutier, general manager of Myers Hyundai in Ottawa, has plastered the dealership with signs advertising 96-month, zero-interest loans.
“People don’t buy price, they buy a payment,” Cloutier, 59, said. Today’s buyer wants monthly payments around C$200, a goal made attainable by longer loan terms and low borrowing costs, he said. Higher interest rates could slow the market or lead some customers to buy a smaller or cheaper car.
There is even scope for loans beyond eight years amid strong consumer demand and industry competition. “At some point, a manufacturer will come out with a longer term,” Cloutier said.