Avoid the Car-Poor Crunch

Kirk Boult, military spouse and new husband of an Aviation Systems Technician in the Royal Canadian Air Force knows all about getting into debt trouble with cars.  When his 10 year-old SUV recently died, Kirk purchased a new Ford 150 that’s costing him dearly:  not only did he fork over a hefty down payment, but he also took out a loan that’s costing him $500 a month for the next seven years.  Weeks later while leaving the dealership with his new truck, his wife had an accident with her own vehicle and the damage was deemed unfixable. Kirk and his wife Sylvie decided to finance the purchase of a sensible mid-sized car costing them an additional $400 a month for four years. “Despite the financial benefits of being a two income couple, the additional car payments, along with some unplanned repairs to our roof last spring, put us further into debt,” says Kirk, who recently began bartending on weekends in an attempt to alleviate some of their current financial strain.

On average, Canadians spend a whopping 17% of their net income on transportation and, according to credit agency Equifax Canada, car loans remain the fastest growing segment of credit debt in most Canadian communities.  Take a tour of any base or wing in Canada, and it’s easy to see that military families are spending a large portion of their pay cheque on transportation.  The cost of purchasing a new vehicle, compounded with the cost of gas and car insurance and the frequency at which some people turn over their cars all contribute to the “car-poor phenomenon”, a term used to describe an uneven distribution of income towards financing transportation costs.

In the opinion of Tom Pedidas, a retired car salesman with over 30 years of dealership experience in both the Edmonton and Calgary areas, this phenomenon is not uncommon among young military members who are often eager to convert their first steady pay cheques into a new vehicle.  “When I first started in sales, the high-end sport utility vehicles would only be pushed on the older clientele who typically enjoyed higher disposable income.  The impact of lower interest rates compounded with longer loans has resulted in a lower monthly payment that ultimately allowed the younger person to buy more.  Basically, many of the younger guys would walk in the dealership with the attitude that they could afford just about anything if they don’t have to pay for it right away.”  Since retiring in 2012, Pedidas has seen even more aggressive changes to the automobile sales game. “Dealerships are now quick to advertise that when you trade in one vehicle to buy another, they will pay off the balance of your loan – no matter how much you owe. But some people owe more on their car than the car is worth. They have ‘negative equity,’ and for them, the dealer’s promise to pay off their entire loan may be misleading.”

To avoid becoming saddled with unmanageable car debt, most industry experts suggest you take the following recommendations into consideration:

1. Do not get caught up in the moment when purchasing a car. Take adequate time to research both your vehicle requirements and budget.  Make sure that you really can afford the payment you are making. As a general rule, try to avoid spending more than 20% of your gross annual income on a new or used vehicle. That’s sound advice whether you’re a Colonel near retirement, or a young Corporal just starting a new family.
2. If you have negative equity, either because of your current car loan or a rollover from a previous loan think about postponing your purchase until you’re in a positive equity position. For example, consider paying down your loan faster by making additional, principal-only payments.
3. “New car” scent is appealing, but new cars lose anywhere from $3,000 to 5,000 in value the second you drive them off the dealer’s lot. If you are financing your car purchase with a loan, this depreciation means that you are instantly “upside down” on your loan (your loan amount is more than the car is worth).  If you do purchase a new vehicle, make sure it is one that you plan to keep for the full financing period.
4. As part of the car buying process, you should shop and compare car loan rates from various sources. Reducing your loan amount and interest rate from 8% to 4% could save you a bundle on the car of your dreams.  Use an online calculator like the one on the APA website  to see whether the bank or factory financing will net you a better deal in the long run.
5. Taxes and registration fees can increase your out-of-pocket cost by as much as 10% or more, and driving a car that’s worth more than your current one will cost more to insure. Be sure to check with your insurance agent or get insurance quotes online so you understand what you’re getting.
6. A big decision while purchasing a vehicle is deciding whether to buy or lease. Leasing is growing in popularity, and represents a viable alternative to buying.  While leasing is generally most attractive for people who want to (and can afford to) drive a new car every three or four years, be mindful of additional charges for excessive mileage (for example, more than 25,000 kilometres a year) and any damage to the car.

By Todd Stride