Many U.S. auto industry watchers are sweating over the potential negative economic impact of long loan terms. But in Canada, where loans terms of 72 months or greater are twice as common as in the U.S., industry experts are keeping their cool.
Traditionally, auto loan terms in the U.S. have been 60 months or so, but now some lenders are offering 84- or even 96-month loans. In April, the average loan period was 67.8 months, Edmunds.com data show.
That has some observers sounding alarms.
While longer loan terms make consumers’ monthly payment seem affordable, they “increase the risk that the loan will outlive the car’s usefulness to the owner,” warned Chris Kukla, senior vice president at the Center for Responsible Lending, in an Automotive News commentary last month. If the borrower’s ability to repay isn’t taken into account, “we risk creating needless economic harm.”
In Canada, where lenders have a history of extending longer loans, there’s no such hand-wringing.
Consider the numbers.
Two-thirds of new-vehicle loans in Canada were for 72 months or more in April, compared with one-third of new-vehicle loans in the U.S.
Loans of 84 months or longer made up only 3.1 percent of the U.S. market last year, and 3.9 percent through April this year, according to J.D. Power. In Canada, the average loan period was 74 months in April. And 8 to 9 percent of loans are as long as 96 months.
Canadian industry experts are comfortable with that.
“It’s not as big of a concern because typically loans have been longer and cars have been more expensive” in Canada than in the U.S., said Robert Karwel, senior manager of J.D. Power’s automotive practice in Canada.
“We’ve been doing 72-month loans a long time,” he said. “It’s not nearly the concern that the U.S. has over these loans.”
Another difference between the two countries: Canadians typically keep their cars longer. So the longer loan terms are matched to longer ownership.
The average period of new-vehicle ownership for Canadian consumers is seven to nine years, said Dennis DesRosiers, head of DesRosiers Automotive Consultants in Richmond Hill, Ontario, outside Toronto. In contrast, the U.S. average new-vehicle ownership period was 6 years and five months, as of the fourth quarter of 2014, according to IHS Automotive data.
“Loans are structured with the knowledge that vehicles are already depreciating assets. I don’t see how auto debt is creating any fundamental problem,” DesRosiers said.
To be sure, Canadian banks and economists are keeping tabs on it, Karwel said.
Canadian consumers recently have been extending their loan periods to 84 months from 72, or to 96 months from 84, Karwel noted, but “we don’t see the loan trend going past 96 months because we see leasing really turning back on.”
Leasing makes up 25 percent of the market now, up from 20 percent a year earlier, he said.
While Canadian new-vehicle sales are forecast to grow slightly this year -- following 2014’s 6 percent rise to a record 1,853,001 -- that will likely be enough to mean a second record year, “which probably will mitigate” the possible impact of lengthening loans on dealers, Karwel said.
At least in the short term.
Some observers in Canada are concerned that longer loan terms mean car buyers will delay their next purchase, he said.
With long loan periods, consumers who decide to come back to the market shortly after their manufacturer warranties expire might still be in a negative equity position.
“So they may hang on to their cars longer until they are out of negative equity,” Karwel said.
DesRosiers said that isn’t the case. Longer loan terms, typically coupled with lower monthly payments, trigger more sales today, he said.
Longer loan periods positively affect the market, he said. Dealers and banks make more money. Even though consumers pay more in the end, they are able to pay over a longer timeframe, and therefore their loan payments are more manageable.
“It’s not like the housing bubble where they were using houses like their piggy banks and their lending levels were outrageous,” DesRosiers said. “With cars you have an asset that you can sell if you are in trouble.”