We’ve talked a lot on this blog before about housing bubbles in Canada. What they are, whether there is one, isn’t one…it’s a subject that’s been just about beat to death. But there’s good reason for hammering away at this particular subject. With housing bubbles come falling home values shortly after, and that means underwater mortgages – another subject we’ve covered here before. But while up until now all the panic has surrounded negative home equity, there’s another kind that might be more alarming, at least for the moment. That’s negative equity in automobiles – and the amount of it currently sitting in Canada.
Negative car equity works just like negative equity in a home. When you owe more on the loan than the asset is worth, whether it’s a car or a home, you have negative equity. Typically this may not be such a huge deal for car owners, as they can simply hang onto their car and wait until they’ve paid off more of the loan before trying to trade in the car again.
But there are a few differences, of course. One cannot overlook the fact that we’re talking about a car in one instance, and a home in another. That difference becomes apparent when you look at the life of loans for both cars and homes. With homes it’s perfectly reasonable to have a long amortization period, because the amount of the loan is so much and that’s a reasonable amount of time to pay it off. With car loans though, long loan lengths are where the trouble with negative equity is really brought to the forefront.
That’s because the long loan terms are adding on additional interest, decreasing the value on an asset that’s already depreciating every day (another huge difference between cars and homes.) When car owners try to trade in their car and put the value towards a new one, it’s then that they find out they have negative equity. They must either keep the vehicle or, as many Canadians are doing, add the amount still owed on the current car to the loan payment on the new car. Add interest onto that, and it could be as much as $300 a year or more that this negative car equity is costing owners, says Robert Varga, president of Walkaway Canada Inc.
And while loan lengths of six years may not seem like a big deal, it is in the automotive industry, and more and more Canadians are scooping up loans with these lengths. In fact, 57 per cent of new car loans in Canada have lengths of six or even more years; and according to J.D. Power and Associates, 30 per cent of vehicles had negative equity at the end of October.
What may even be the bigger concern is that Canadians are keeping themselves in debt for that length of time – and at a time when the Bank of Canada and the Finance Minister continue to warn us about not taking on too much debt. Especially auto loans, which surveys have showed are one of the only areas where borrowing is still up.