Many Canadians look forward to purchasing a new car, as it can make your commute to work easier or provide more options when shuffling kids around.
But it can be hard to determine how much to exactly spend on new wheels.
Taking on increasingly longer car leases and locking into a deal that’s more than you can afford is a common problem, said finance expert Preet Banerjee.
More than 50 per cent of new car loans in Canada are seven years or longer he told hosts on Global’s The Morning Show.
“For luxury cars, you can actually get loans for 12 years,” he explained. “It seems like it’s more affordable, but it’s not.”
If you’re eager to have a low monthly car payment, it’s in your best interest to go after a cheaper car rather than take out an eight-year payment scheme, he said.
Having low monthly payments on a brand new vehicle can be enticing, especially if it fits with your monthly budget. But you do run into danger as a longer lease could lead to negative equity, according to a previous Global News report.
Negative equity occurs when the amount you owe on, in this case, a car is higher than its value. Your car’s value depreciates over time and the problem will get worse if you try to trade in your car before it’s fully paid off, said Banerjee.
Trading in your vehicle too early means the debt from that car migrates to payments for the next shiny new vehicle, throwing you potentially into more debt, Brian Murphy, vice-president of data and analytics at Canadian Black Book, previously told Global News.
“Eventually, you’ll be asking for a loan that is too big compared to the asset that you’re buying,” he said, which your bank will not approve.
According to J.D. Power, more than 30 per cent of Canadians who trade in a car owe more on the car than what it’s actually worth, explained Banerjee.
“This is a recipe for disaster,” he said, as it allows debt to compound.
Just because your monthly payments are low doesn’t mean you haven’t taken on a large amount of debt in total, said George Iny, executive director of the Automobile Protection Association, in a previous Global News report.
“Over time, you’ve just taken on $30,000 to $35,000 of new debt,” said Iny. “A lot of people seem to be strangely unaware of that — and dealers encourage it.”
Subprime auto loans: Why you should avoid them
A subprime loan is a high-risk loan to someone with poor credit, said Banerjee. These loans come with higher interest rates and potentially less favourable terms and penalties for missed payments.
More Canadians are taking on subprime auto loans than you might think, as close to 25 per cent of loans fall into this category, revealed Banerjee.
There’s an easy rule to follow to ensure you aren’t at risk for potentially piling on an unmanageable debt load, he said.
Use the “20-4-10” rule by putting a 20 per cent down payment on your car, taking out a loan that’s no longer than four years, and avoiding payments that eat up more than 10 per cent of your income.
“That tells you you can afford that car,” he said. “If you go beyond that, like a lot of Canadians are, you’re really showing that you’re living paycheque-to-paycheque, and there’s only so long that can continue.”
For more tips on how much you should spend on a new car, watch Preet Banerjee in the video above.
—With files from Global News reporter Erica Alini.