Negative equity in car buying: what every consumer should know

Higher interest rates and longer loan repayment schedules increase your vulnerability to having a car that’s worth less than the debt you owe

Graham Michaels  •  Postmedia Content Works

The current high interest rates in the Canadian auto market are leading to higher monthly payments and longer loan terms for car buyers who finance their vehicle purchase. Last month, we explored how these factors increase the cost of borrowing and can add thousands of dollars to the purchase price.

But high interest rates and longer loan terms also increase the risk of slipping into negative equity. This is the situation when the value of your car is lower than the amount of money you still owe against it. Higher rates and longer terms mean that the principal amount – the sum of money borrowed to buy the car itself rather than to pay the financing cost – is repaid more slowly. In the meantime, the car’s value depreciates. That depreciation accumulates over time and can outstrip the repayments, increasing the likelihood of negative equity.

“Our consumer support team gets lots of calls about negative equity,” says Jeff Donnelly, chief consumer protection officer at OMVIC, Ontario’s motor vehicle sales regulator. “Even prime loans to customers with good credit history can lead to negative equity because of higher APR (annual percentage rate), interest rates and longer loan terms. It’s all about affordability. Long-term loans are enticing because they may allow you to buy something you normally can’t afford, even if you can make the monthly payment.”

The risk of negative equity is even greater with a subprime loan. Drivers with poor credit history, or no history at all, may not be eligible for the interest rates offered through dealerships, where credit is often backed by major banks or the auto makers’ finance arms. In the current market, anything from around 12 per cent upward might be classed as a subprime loan rate, although calls to the consumer support team at OMVIC reveal that percentage rates into the 20s or even 30s are not uncommon.

Buying a vehicle with a subprime loan can look very different to the conventional experience of visiting showrooms, choosing between different models and then negotiating a finance deal. Often, you’ll shop the finance first, perhaps through an ‘anyone approved’-promoted website. Then, the consumer may – or may not – be given a choice of vehicle. Unfortunately, vulnerable consumers with poor credit, but who still need a car to get to work or to take care of their families, may feel they have no other option than a costly subprime finance deal that can lead to problems down the road.

However, if you finance your vehicle – prime or subprime – negative equity will not be an issue if you keep up the payments and do not try to sell the vehicle early with lots of debt left to repay. But the elevated risk of a major mechanical problem that comes with the older or higher-mileage vehicles typically being offered to subprime buyers increases the exposure to negativity equity.

In that situation, if you can’t fix the fault and need to start looking for another car, you may not be able to get financing on another one, typically because there will be little or no trade-in value against the old vehicle and partly because the value of the old car will likely fall far short of the value of the outstanding loan. Even if you can secure replacement wheels, the balance of the old loan doesn’t go away, it just carries over into your next car.

“You can minimize the risk of negative equity by not borrowing more than you can afford to repay, not just this month and next, but over the entire term of the loan,” advises Donnelly. “Remember, too, that there is no cooling-off period for vehicle purchases in Ontario, so it’s important to understand exactly what you’re signing, before you sign it.”

OMVIC has been delegated responsibility for administering and enforcing the Motor Vehicle Dealers Act (MVDA). Visit omvic.ca to learn about your consumer rights when you purchase from an OMVIC-registered dealer and sign up for OMVIC’s monthly newsletter.

Contact OMVIC’s consumer support team at [email protected] or 1-800-943-6002 for advice and answers to all your car-buying questions.

OMVIC also offers free education services and webinars for consumers upon request. To learn more about your rights as a consumer, contact [email protected] for more information on our services and materials.

Our new OMVIC website has been designed to empower car-buyers like you. Whether you’re in the market for a new car, seeking expert advice, or simply exploring your rights as a buyer, our website is your gateway to a wealth of information. With a mobile-responsive design, intuitive navigation, and engaging content, we’re committed to making your experience seamless and informative. Dive into our fresh platform and take control of your consumer journey.

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