How to avoid the negative debt trap when financing your next car

It’s not just the monthly payment amount that determines whether your car loan is affordable.

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If you owe more money on your car or truck than the vehicle is worth, this is called negative equity. If you haven’t heard of negative equity, you’re not alone, but it’s a problem for many consumers. According to OMVIC, Ontario’s vehicle sales regulator, car dealerships routinely report that more than 50% of trade-in customers have negative equity. So how is it going?

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For many consumers, negative equity is the direct result of historically low interest rates combined with extended repayment terms. It wasn’t that long ago that 48 or 60 month auto loans were the norm, but today it’s common for buyers to finance their vehicle for 84, 96, or even 108 months.

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Financing a car for a longer period reduces the monthly repayment amount to a more affordable level, putting more expensive vehicles within reach of more buyers. However, seven years or more is a significant length of time for a product that begins to depreciate the second it is kicked out of the lot. Many vehicles depreciate quickly, especially if they are driven above average distances, such as commuting. Therefore, long financing terms are not without risk.

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Let’s take an enthusiastic car buyer, Chris, as an example. Chris likes to change cars every three years. He is now tired of the one he bought three years ago, but he has a seven-year loan, with four more years to pay. The dealer assessed the trade-in value at $10,000, but Chris still owes $15,000. That extra $5,000 doesn’t just disappear. Instead, when he finances his next vehicle for another seven years, the $5,000 outstanding from the first car will be added to the new loan. And if he tries to buy a third vehicle in three years, a second block of negative equity will be added. Soon Chris will reach a point where he will owe so much that the bank may refuse to fund his negative equity any longer.

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Before accepting a long-term loan for the purchase of a vehicle, consumers should consider how long they will drive, how long they intend to keep the vehicle, and how quickly it will depreciate. In short: make sure you are informed.

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“It’s important to understand the risks that are involved in auto financing,” says Tim Hines, director of consumer support at OMVIC. “When you buy a car, pay attention not only to the monthly payments, but also to the term of the loan and the overall price of the car. Maybe you need to buy a cheaper car to get something that fits your monthly budget, rather than finance the more expensive car for longer. If you plan to trade in the car after five years, you may be more comfortable with the $25,000 car over five years than the $30,000 car over seven years.

Hines notes that every consumer’s situation is different. For someone who intends to keep a car for the rest of its life, a longer-term loan may make sense. Other buyers use a cash deposit to reduce monthly payments or make additional payments to shorten repayment time.

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Whatever your situation, it’s important to educate yourself and make the right decision because the consequences can be serious if you don’t. Worst-case scenario, if the vehicle needs a major repair that you can’t afford and it’s rendered impassable – and therefore worth nothing in return – you’ll be left without a car and with a pile of debt. unpaid. The recovery could follow. And the bad news for consumers is that as interest rates rise, banks will be less willing to absorb some of the negative equity into a new auto loan, putting even more borrowers at risk.

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Dealerships are required to expressly state when existing negative equity is part of a new vehicle financing arrangement. Greater transparency is required under Ontario’s Consumer Protection Act and Motor Vehicle Dealers Act, including clearly stating the annual percentage rate (APR) and total cost of borrowing – the total price you will pay for a financed vehicle. Careful consideration of this information will help you make an informed decision. Keep in mind that if a reputable dealer’s bank refuses to fund a trade because of the negative equity risk, it could be doing you a favor. The dealer around the corner who promises to give you credit anyway probably doesn’t have your long-term best interests at heart.

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“Some people can afford to pay off negative equity on their own, and that’s fine,” says Hines. “But OMVIC gets calls from people who can’t. Most of these car buyers did not educate themselves before entering into a completely legal and legally binding loan agreement. We urge consumers to do their research ahead of time and stay out of trouble.

Visit OMVIC.ca to access free resources on buying cars to get started and sign up for the Consumer Line e-newsletter, and contact OMVIC’s Consumer Support Team at [email protected] or 1-800-943-6002 for answers. to all your questions about buying a car. To find out if you are eligible to receive financial assistance from the Compensation Fund, contact OMVIC at 1-800-943-6002 or email [email protected]

This story was created by content workspostmedia’s commercial content division, on behalf of OMVIC.

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