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Car loans have long been Canadians’ second largest liability after mortgages, but since the pandemic hit, some advisors have noticed their clients’ vehicle debt ballooning.
“I used to see [client] car payments as $250 to $500 a month. Now, they’re much, much higher,” says Liz Schieck, certified financial planner (CFP) at Toronto-based New School of Finance. “I see $800, $1,000 a month and financed for longer periods of time.”
The main culprit is the price of vehicles today, which have escalated as much as 33 per cent since February 2020 due to a global microchip shortage, production issues, and overall demand exceeding supply. The average new vehicle now costs $53,000, while an average used car is $37,758 – a 38 per cent increase from April 2021, according to recent data from AutoTrader.
Ideally, clients would mention their intentions of purchasing a vehicle upfront but it doesn’t always work out that way, says Steve Bridge, an advice-only CFP at Money Coaches Canada Inc. in Vancouver.
“The challenge is people are coming to me after the deed is done and they have this $700, $800 [monthly] line item for the foreseeable future,” he says.
He recalls a client who had financed a new car over seven years with 4.5 per cent interest. Unfortunately, the client had only considered the monthly car payment instead of the overall cost of the vehicle and how much interest he would have to pay over the term of the car loan.
Mr. Bridge wishes he had the opportunity to run some numbers with the client ahead of time and investigate alternatives.
While his client manages the monthly payment, there is a cost. The car loan is impeding on the client’s ability to save more toward a much-desired house down payment.
“If you have a new extra expense every month, that makes achieving other goals really hard because cash flow is tighter,” he says. “That’s why planning in advance matters.”
Delay purchasing, look for deals
Given the auto industry’s current challenges, Mr. Bridge advises clients wanting a new vehicle to postpone if they can and continue to set money aside toward the car purchase.
“In the meantime, they could keep up with their research on particular brands and test drive some cars,” he says.
At the same time, he tells clients to look out for deals from motivated private sellers. For example, if someone suddenly needs to relocate, they may be more open to price negotiation as they need to sell quickly.
Shannon Tatlock, CFP and associate advisor with Kevin R Williams Financial Services Inc. at Sun Life Financial Investment Services (Canada) Inc. in Moncton, also says that clients should delay purchasing a new car in this environment.
Some of her clients “are having a hard time finding cars and they’re not getting the deals they could find previously.”
But not everyone can delay, so Ms. Tatlock provides her clients with an interactive spreadsheet that outlines all the ideal allocations of various line items.
“When clients add in the amounts of their car payment, insurance and gas to the spreadsheet, it will let them know whether they’re spending too much for their budget,” she explains. “If they really want the car, they’ll know they’ll have to take money from other areas of their budget and be okay with that.”
Budgeting for repairs and financing
Ms. Tatlock notes that transportation costs, including gas, insurance, and maintenance, should not exceed more than 10 to 20 per cent of a monthly household budget, depending on if a client is single, part of a couple, or a family with children.
She also says clients should take a second look at repairs on their older car to see if it still makes sense financially. She offers the choice of paying a $2,000 mechanic bill on a paid-off car or paying $6,000 this year toward a new vehicle.
“Would you rather pay $2,000 now or $6,000 over the course of a year?” Ms. Tatlock asks, noting that most clients in that scenario will choose to repair the car. While paying a hefty amount hurts up front, “it’s actually less over time,” she says.
Ms. Schieck starts off vehicle discussions with a simple question: why do you need the car? In many cases, the answer is obvious – a long commute to the office, a second vehicle to make family errands easier. Some want to replace their car with an electric vehicle to save on gas and for other environmental reasons.
She notes that some view cars as a status symbol, an extension of themselves, and feel it’s worth it to pay an extra few hundred a month to upgrade their vehicle features.
“If they have room in their budget and they’re happy spending, then great,” Ms. Schieck says. “We then look at what they could adjust to make room for their car payment and whether it’s sustainable.”
Clients need to consider whether it’s actually affordable to keep carrying a big loan for up to seven years or will they eventually be bored of the car features, she adds.
For any car financing, Ms. Schieck says clients should secure an open type of loan, which allows them to pay off the car more quickly without penalty.
“If a client ends up earning a big bonus, for example, they could clear their loan in three years instead of seven years,” she notes.
Finally, Ms. Schieck encourages clients to consider all their options such as taking public transit or taxis and joining a car share membership if they live and work in an urban area.
While car shares may be a bit more inconvenient, there’s also no worry about gas, insurance and repair bills.
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