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Long-term loans: The fuel that’s powering Canadian car sales

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This story is part of a series we’re calling Debt Nation looking at the state of consumer debt in Canada. Look for more coverage in the coming days, including on mortgages and credit card debt.

Canadians are buying more cars than almost ever before, but a closer look reveals they’re taking longer and longer to pay them off, too.

More than half of all new car loans are currently financed for  84 months — seven years — or longer. Industry standard used to be to amortize car loans over 60 months — five years — but as low interest rates settled in, payment periods began to stretch longer and longer to make monthly payments as low as possible.

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Longer terms allow the lender make more money in interest payments off each car loan.

Interest rates on car loans can range from zero per cent to the high single digits, depending on the make and model, time of year and the duration of the loan.

Market research firm J.D. Power Inc. collects sales data from more than 1,200 Canadian car dealerships across the country, and has noticed a troubling trend.

In a nutshell, “long-term financing has exploded in Canada,” the company’s automotive expert Robert Karwel said. At one point earlier this year, 55 per cent of all new car loans were for at least 84 months.

That can be than seven years to pay off a steadily depreciating asset, and it’s a growing piece of Canada’s debt puzzle.

The figure has since inched down a little to 51 per cent as of September, Karwel says, but for comparison purposes less than 10 per cent of American car loans are stretched out over that long a period.

Most are fixed-rate loans, but even so, if Canadians are five times more likely than Americans are to have a long-term car loan, they’re five times more vulnerable down the line as the cost of all their other forms of debt creeps higher.

“People are buying more expensive cars, and that’s been facilitated by [this type of] financing, because you can spread the payment over long enough of a time,” Karwel says.

Canadians are on track to buy two million vehicles this year, but more and more people are taking seven years or more to pay them off. (Eduard Korniyenko/Reuters)

The appeal for a car buyer is obvious.

The average price of a new car in Canada last year was just over $33,000 last year. If you pay cash up front, you’d likely get to knock off quite a bit of that total in terms of dealer incentives and instant rebates.

But if you finance it over seven years or more, it’s not hard to get the monthly payment to well under $500 a month, and even a modest down payment up front would result in much lower payments down the line.

Read more stories in our Debt Nation series:

COMING UP:

  • WEDNESDAY | Full news coverage of Bank of Canada announcement on interest rates
  • THURSDAY | CBC business reporter Peter Armstrong takes a look at the current state of household debt in Canada; Don Pittis analyzes what the Bank of Canada news means for Canadians’ finances
  • FRIDAY | CBC business columnist Don Pittis explains why credit card debt can be a dangerous trap

Squeezing that same car into shorter-term loan saves money in the end but can add hundreds of dollars to the monthly payment.

Which is a big reason why B.C. resident Jakky McDonald jumped at the chance to get an 84-month loan when she bought a new Kia Forte earlier this year.

Jakky McDonald is more than satisfied with her seven-year car loan because the terms allowed her to pay off her student loan. (Glen Kugelstadt/CBC)

The 24-year-old wasn’t in a position to pay cash up front, so she knew she’d finance.

Based on what the dealer offered, she went with a seven-year payment plan, but the salesman pitched her on one extra enticement she couldn’t refuse. While checking her credit history, the salesman noticed that she had about $4,500 in student loans on her file. He suggested she roll those debt into her new zero per cent interest car loan.

“He said you might want to consider taking any other debt you might have that does have interest on it, you know, to this because it will save you money in the long run,” she recalls him saying.

She checked the fine print, and ended up doing exactly that. Six months later, she says she’d make the same call in a heartbeat. In McDonald’s case, the plan hinged on getting zero per cent on the loan.

True, she may have missed out on a few other incentives had she paid cash up front, but refinancing almost $5,000 worth of student loan debt in one fell swoop worked for her.

Albertans tend to have the biggest amount of car-related debt, partly because of the province’s penchant for expensive pickup trucks, TransUnion’s Matt Fabian says. (CBC)

“I opted for $4,500 cash back and then they wrote me a check for that,” she said. “And I just went and put it right on my loan.”

Her case clearly illustrates the selling point for consumers of some of these loans — but it’s not hard to come up with the down side.

Experts say that one of the biggest risks of such loans is that as the loan terms stretch into seven eight or even nine years, it’s not uncommon for the borrower to still owe more against the car than it’s worth, when they come to need another car in a few years time.

In financial parlance, that’s known as having negative equity, but in layman’s terms it feels a bit like having your finances turned upside down and underwater.

Dealers lure in buyers with incentives like zero per cent financing, but those enticements often come with incredibly long term payment periods and no rebates up front. (Daniel Acker/Bloomberg)

J.D. Power numbers suggest that more than 30 per cent of Canadians who trade in a car owe more on the car than it’s worth.

More often than not, that gap gets rolled into the new car loan in the form of new debt, which extends the payment plan even further and puts borrowers even more in debt when they need to do it again in a few years time. And the cycle goes on. And on. The longer the loan, the more likely it is to present a problem down the line.

“You’re just spreading that same risk over a … longer period of time,” says Matt Fabian, research director at credit reporting firm TransUnion.

While Fabian notes that delinquency rates for car loans are still low, long-term car loans are a growing piece of Canada’s debt picture — especially as Canadians are buying bigger, more expensive cars.

Most car loans come at a fixed rate, a fact that makes them somewhat insured from rate hikes to come. But that hides  the reality that hikes elsewhere can make even those car payments even hard to come up with every month.

Almost half of new car buyers trade in an old car to help finance the purchase of a new one, but almost a third of them are upside down on their old car anyway. (CBC)

“That car loan payment doesn’t increase, but if you have a variable rate mortgage and a line of credit, those do,” Fabian says.

Economist Benjamin Tal at CIBC agrees that car loans are really a matter for concern in as much as they fit into Canadians’ overall debt loads.

But he’s especially worried about people with negative equity — who owe more than their car is worth, even after years of paying it off.

Because consistently doing that means “you’re becoming more vulnerable to the risk of higher interest rates,” as he puts it.

That may sound bleak, but fortunately, J.D. Power’s Karwel says there’s an easy solution to the problem.

“For consumers at least, there’s a safety valve for all this … and the safety valve is … just keep your car. If you’re financing for 84 months, keep your car for 84 months and this problem goes away.”

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11-Step Guide to Buying A House

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Purchasing a home is likely going to be one of the largest purchases you will make in your lifetime, which is why it is so important to follow the right steps when starting on your home-buying journey to ensure that the entire process goes smoothly from start to finish!

We’ve put together a step-by-step guide to buying a home, to help you get off on the right foot when it comes to buying a home. Click the download button below to download these steps in PDF form.

1. Decide to buy a home

Make sure you are ready both financially and emotionally!

2. Get Pre-Approved

Work with a mortgage broker or your bank. They will work with you on what you require to submit an application. Once approved, this will determine how much you can afford to spend on a home.

3. REALTOR® Consultation

Work with a RE/MAX agent to help guide you through the process. The right agent will discuss your price range, ideal locations, current market conditions and much more!

4. Start Your Search

Your REALTOR® will get you information on new homes that meet your criteria as soon as they’re listed. They’ll work with you and for you to ensure you find your dream home.

5. Current Market Conditions

Your experienced RE/MAX agent is a valuable resource as you consider different properties. They will be there when you have questions regarding the homes you’re interested in – they can tell you what is a good deal, and when to walk away.

6. Make an Offer

Your REALTOR® will help create your offer tailored to your needs including the right subject clauses down to the closing date that works best for you.

7. Negotiate

You may receive a counter offer but don’t be worried! RE/MAX agents will negotiate for you to ensure you get the best possible price for the house you love!

8. Accepted Offer

It’s crunch time! The next few weeks are busy as you need to schedule and remove every one of your subject clauses by the specified date. You’ll likely need to schedule an inspection, appraisal, financing approval, and several others. You will also need to provide a deposit to put down on the home. The deposit will be a pre-determined amount given in-trust to your REALTOR® to show the sellers you are committed to this home. Don’t worry, that money goes towards the purchase of said home if all goes well! This is a busy time but be sure to reach out to your RE/MAX agent if you have any questions or are unsure about next steps.

9. Subject Removal

Once you have completed all your subject clauses, and everything went smooth, it is time for you to sign on the dotted line and consider your new home to be yours (almost!).

10. Official Documents

You will need to provide your RE/MAX agent with your preferred lawyer or notary to have the official title transferred into your name. You will meet with the lawyer or notary in person to sign all the legal documents before you move in. This typically happens a few days before you take possession of your new home.

11. Move In!

Congratulations, you are officially a homeowner! The date pre-determined by you is your move-in day! You can now move into your new home. Your RE/MAX agent will be there ready and waiting to hand you the keys. Enjoy!

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Know When to Rent ‘Em, Know When to Buy ‘Em

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We’re told it’s always better to buy than rent. Everyone—from our parents to the banks to the government—encourages us to buy, buy, buy our homes.

But times have changed, and I dare say that these authority figures might be slightly out of touch. The jaw-droppingly high cost of real estate in big cities is encouraging millennials to rent instead of own, causing homeownership rates to drop. At 30 years old, 50.2% of millennials own homes versus 55% of baby boomers at the same age. As a millennial homeowner, I can’t help but wonder if I’m generationally displaced.

There’s an old misconception out there about renting that needs to be addressed. You’re not “throwing away your money” if you’re renting. While that familiar axiom might be true sometimes, there are plenty of circumstances in which it does actually make more sense to rent than buy.

You Might Choose to Rent If…

…You Invest What You Save

Renting tends to come with lower carrying costs than owning. Typically, all you’ll have to worry about paying as a renter is, well, the rent (clearly) and perhaps a share of utilities. This leaves you with extra monthly cash to invest, which can ultimately put you on even financial footing or better with a homeowner.

As always, there’s a familiar caveat here: You need to be financially disciplined for this strategy to pay off. One mistake I see a lot is that those who rent tend to fall prey to something called ‘lifestyle inflation.’ Rather than investing what they save as renters, they just rent nicer apartments, eat at fancier restaurants, and put more money into their wardrobe than their RRSP. But this money vacuum can be easily avoided by:

1. Budgeting to find out how much you have left over to invest each month after factoring out all your expenses, then;

2. Funneling that leftover money directly into your investments. Some robo-advisors, like Wealthsimple, allow you to do this automatically via pre-authorized contributions, which set recurring transfers from your chequing account into your investment portfolio, at whatever amount and interval you choose.

…You Have Rent Control, aka the Urban Holy Grail

Depending on where you live, you might be lucky enough to benefit from the urban miracle known as rent control. That means your landlord can only increase your rent by the rate of inflation, which in turn keeps your cost of living way down and leaves you with more money to invest. In Canada, rent control is now implemented in most big cities like Toronto and Vancouver (although not in Montreal).

…You Have a Mobile Lifestyle

Renting makes it easier to move; if you’d like to relocate it’s usually as simple as giving your landlord 60 days written notice. But when you own a home you’re more tied down, and the obligation to be near your property may prevent you from chasing new adventures in faraway lands. I once turned down a fantastic job opportunity in Dallas, Texas for this very reason.

…You’re on a Tight Budget

Renting tends to be more affordable than buying in big cities like Toronto and Vancouver. I know, I know, renting is still unreasonably pricey in certain neighborhoods. But buying in those same areas can be arm-and-a-leg expensive.

When you rent, all you have to come up with is the first and last month’s rent; no need to scrimp and save to pull together a massive down payment on a house, which, incidentally, will take you two to four times longer to save than it did your parents.

And homeownership leads to a lot of other costs aside from mortgage payments. When you buy real estate, you’ll need to pay closing costs, which typically add up to between 1.5%–4% of the property’s purchase price and can include a home inspection fee, real estate lawyer fee, land transfer taxes, and homeowners insurance (sometimes you’ll have to fork over an entire year’s worth of home insurance as one lump sum).

There’s also the elephant in the room that nobody likes to speak about: repairs and maintenance. Homeowners are responsible for paying the big bucks for costly home repairs, such as a new roof and furnace, and are advised to set aside 3–5% of a home’s value toward home repairs and maintenance each year. Renters, on the other hand, can just call their landlord whenever they need repairs (provided the landlord actually picks up). Still, it’s important that tenants know their rights when renting to be aware of which fees do and don’t fall under their responsibility.

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A Montreal Real Estate Broker Answered 5 Qs About Buying A Property To Rent Out

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You’ve probably heard that Montreal’s real estate market is on fire. But how can you get in on the action? According to Alex Marshall, a local real estate broker, buying a property as an investment for the purpose of renting it out is a great way to go about it.

Marshall, who’s part of the Keller Williams Prestige team, sat down with us to explain why and how to purchase an investment property. These types of properties are also known as revenue properties.

Why do you recommend buying a revenue property?

Marshall used personal experience to highlight the advantages of owning a revenue property. He’s currently renting out the Saint-Henri loft he bought in 2010.

“Not only is my tenant paying off my mortgage, but I’m making a couple 100 bucks a month as well,” Marshall said.

Marshall was also able to take out a line of credit on the property, he said, and use the equity to buy an additional property.

“You actually don’t need to live in the property that you buy. I’m seeing clients who are in apartments with low rent [who] don’t want to move but have got the money right now … and are looking for smart ways to invest,” he said.

What are some tips to help people save up for a revenue property?

When Marshall was saving up to buy his first property, he said he worked a second job. 

“There’s a lot of value to having that side hustle … even if it’s at Subway or it’s at a landscaping company on Saturdays. It will add up significantly in the long run,” he said.

He gave the example of adding $5,000 to your annual income.

Marshall said you can qualify to borrow roughly four times your annual salary for a mortgage so $5,000 could actually provide you with an extra $20,000 of buying power.

“That might get you a second bedroom, that might get you a parking spot, that might get you a larger space,” he said.

The pandemic, Marshall said, has also helped some of his clients save extra funds.

“You can’t travel, you can’t go to the restaurant, you can’t go to the theatre, you can’t go to the bar. So a lot of people right now are finding themselves with almost a disposable income,” he said.

Marshall also recommends looking into Canada’s Home Buyers’ Plan program, which allows you to withdraw up to $35,000 — — tax-free — from your registered retirement savings plan (RRSP) to put toward buying or building a qualifying home. 

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