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Be Wary of Major Banks Promoting “Risky” Auto Loans

Posted by Auto Loan Solutions

Have you noticed that there’s a lot more flashy cars out on the roads these days? Seen more brand new Range Rovers and Audis than you’re normally accustomed?

Well, you’re not the only one.

According to a recent report from Moody’s Investor Services, Canadians have “shifted preferences” towards more expensive vehicles over the past few years. The catalyst? Affordable, albeit “risky,” new auto loan rates promoted by our country’s major banks like TD, RBC and Scotiabank.

Risky Car Loans Being Promoted By Major Banks

These financial institutions have been vigorously promoting auto financing since the end of the last recession, says Moody’s. Coupled with new eight-year car loans, which have increased dramatically within many Canadian banks, Canadian consumers are now buying “more car” for the same payment they’d make on a less expensive vehicle, but will pay it back for much longer, according to Moody’s analyst Jason Mercer.

“Low monthly payments facilitated by low interest rates and longer amortization periods are encouraging consumers to purchase more expensive vehicles,” explains Moody’s.

In fact, as reported by experts in the field, banks have essentially ditched the traditional 60-month (five year) loan rate in favour of financing terms paid back in 84, or even 96 months. Due to this new trend, overall car loan debt has risen by 20% over the last year, an inordinately fast rate.

For example, loans on passenger vehicles amounted to over $64 billion at the end of 2013. Only six years prior, in 2007, auto loan debt in Canada was at a quarter of that, at $16.2 billion.

What’s the Downside?

With borrowers being easily convinced into buying more expensive cars because it will cost them the same monthly, they should take note that they’ll be paying much more OVERALL. Particularly, as a new car begins to depreciate in value the moment you drive it off the lot, Canadian consumers could even find themselves paying much more than the car is worth if they’re repaying it over eight years.

Picture this: you took out an auto loan with an 8-year-term at reasonably low interest rates. Five years into your term, your car has decreased significantly in value, and may even be worth the amount you STILL owe to the lender. In a nutshell, it’s not the most practical or economical decision to buy a brand new car if the only way you can afford to pay for it is over the course of eight years. Even if you’re eligible for refinancing – which depends on your loan, so make sure you understand the terms before signing anything – you’ll still be paying off a car eight years after you bought it, unless you’re able to change the timeframe when you refinance. Food for thought.

According to Moody’s, this risky buying trend can be detrimental to both consumers AND banks. Regarding the latter, it seems that by taking these riskier approaches, banks are providing “evident demonstration” that lending standards are indeed loosening.

Regarding the former, the trend has the potential to put borrowers on a “debt treadmill,” says Mercer. By taking such loans, borrowers are prolonging their debt, which makes it more difficult for them to pay it off. And once they start falling behind on bill payments, well, that’s when their credit score takes a turn for the worse. In order to avoid this, click here to check out our 6 Simple Ways to Get Out of Debt.

“The treadmill can only end in one of two ways,” explains Mercer, adding that either the borrower does pay off the loan on time, and maintain their payments throughout the lengthy period, OR they find themselves unable to pay, and eventually could even file for bankruptcy or a consumer proposal.

 A Flashy New Car Is Not Worth A Bad Credit Rating

Maybach Exelero

Financial experts have questioned this new trend of “risky” loans because it can oft be a lose-lose scenario. When borrowers CAN’T afford to pay off their bills, lenders are forced to pursue extreme measures such as repossessing the vehicle – which usually entails that they’ll lose money on the loan due to extra charges and bills. At this point, even if your car has been repossessed and you can’t afford to get it back, you’ll still be responsible for the lien (the balance left on the vehicle), and creditors can even sue you for it.

Of course, it goes without saying that this would also be harmful for your credit score.

At Auto Loan Solutions, Ontario’s largest auto loan supplier, our specialists usually advise our clients with poor credit scores to buy less expensive, used vehicles. Why? Because people with lower credit scores have to pay higher interest rates until they get their credit back in shape. With a less expensive car, you’ll pay less in interest, which will make it easier for you to pay your bills on time, and will also help strengthen your credit rating. That way, typically after a year, you’ll be able to refinance the terms of your loan and get better rates.

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