How Can Car Loans Lead to Insolvency?

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Posted in Debt Help
Posted by J. Douglas Hoyes, CA, CPA, LIT, CIRP, CBV

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There are two major purchases we make in our life that we typically use debt to purchase. The first (no surprise here) is our home, and the second is our car. But can car loans lead to insolvency? Believe it or not, yes car loans can lead to insolvency.

As cars are getting more sophisticated and fitted with new gadgets and features, which means they’re also getting more expensive. You’re no longer buying just a car, you’re buying a driving computer. Instead of the days where we could just pay cash up front for our vehicle, we’re presented with loans and leases as a way to stretch the total amount over a number of years. In some cases, car loans extend up to eight years.

This makes cars more affordable for the every day consumer, which is great for car companies as they’re able to continue with the technological evolution of their cars.

How Car Loans Could Lead to Debt Problems

Because there are always newer, more technologically advanced cars coming out, people trade in after a few years to get a newer model. If they were paying for each car in cash, that would be great for the dealer and great for the consumer. But a statistic from DesRosiers Automotive Consultants states that 85% of cars are now bought with debt.

Consumers have started trading in their car, which they paid $30,000 a few years ago and they still owe $15,000 on the car. The car’s trade-in value is only $10,000 now so you’re rolling $5,000 over into your new car loan. So the shiny new $30,000 car is actually costing you $5,000 when you factor in the money you still owe on your previous vehicle.

That’s fine if it’s a one-time transaction, but if you’re getting a new car every two or three years, those rollover costs add up.

Car Loans and Insolvency

Our Joe Debtor study showed that insolvent Ontarians trading in cars with negative equity was 34%. Negative equity means that they owed more to their creditor than what their car was worth in resale value.

If you are considering a bankruptcy or consumer proposal it’s important to know that you can keep your car after filing insolvency. Your car is a secured asset so, if you can maintain your car payments, you can keep your car. Something you may want to think of is “is it worth it?”

If your car is only worth $10,000 for a trade-in or resale, does it make sense to pay off your remaining $15,000 that you owe to your creditor? Depending on your situation, it may make more sense to return the car to the dealership, and include the shortfall into your bankruptcy or consumer proposal.

How Can You Avoid Car Loan Debt?

If you’re looking for ways to avoid car loan debt altogether, we have some tips for you. One of the most important pieces of information is to ask how much the total value of the car is.

If I were to pay cash for this car, how much would it cost me?

Many people get blindsided by the affordable monthly payments and don’t necessarily calculate the amount they’re spending over the life of their loan. If you’re paying off a car with a six year loan, the interest may add up to you spending an additional $5,000 or even $10,000 on your car. Here are practical tips to keep in mind:

  • keep your loan period as short as possible,
  • save as big of a down payment as possible,
  • if you get into trouble, get professional advice.

Resources mentioned in this show:

FULL TRANSCRIPT show #141 Doug Hoyes on Ask The Experts

how-can-car-loans-lead-to-insolvency-transcriptDoug Hoyes: Today’s show and next week’s show will be a bit different. wiNormally I’m the host of this show and I interview a guest, but today I’m the guest. I’m going to play you the first half of an interview I did with Dave Callander on the Ask the Experts show, broadcast on May 6th on 570 News in Kitchener.

Dave asked me about how people get into debt problems with cars. I tell him some stories about how people end up owing a lot more on their car than it’s worth, and we talk about practical solutions to the problem of debt in cars.

But before Dave asked me about cars, it’s been a year or two since I was on Dave’s show, and in that time our profession changed its name. So Dave started the interview by asking me about that name change. So let’s pick up the show with Dave’s first question about why we changed our name.

Dave Callander: Before we get into the meat of today’s discussion, it’s been a while, as you say, since you’ve been on the show. Last time you were here I think I referred to you as a Bankruptcy Trustee, but now I hear you’ve gone and changed your name to Licensed Insolvency Trustee. What’s up with that change?

Doug Hoyes: Well so it wasn’t actually me who changed it. It was the federal government of Canada who implemented the change, as the government is want to do, on April 1st of 2017, April Fool’s Day. They decided that what we do is help people with their debt issues. And we don’t just do bankruptcy. And in fact, at Hoyes Michalos we do fewer bankruptcies than we do consumer proposals.

And so calling ourselves Bankruptcy Trustees kind of cuts out a big portion of what we do. So all trustees are now known as Licensed Insolvency Trustees, and there are two components to that, licensed meaning we are actually licensed by the federal government of Canada. There’s lots of people out there who say “Oh I can help you with your debts no problem. Give us a call, pay us some money, we’ll take care of it.” Well, they actually can’t.

We are the only ones who are able to use the force of law to help you deal with your debts. And insolvency of course is what we do. If you’ve got more debts than you can handle, then it’s a Licensed Insolvency Trustee that you need to deal with.

Dave Callander: Maybe you could tell us a little bit more about Hoyes Michalos, for folks who haven’t heard you on the show before.

Doug Hoyes: Well as I said, we help people with debt. So the typical person we deal with would have had a good job at some point in the past, they were able to get some credit and then something happened. Perhaps they lost their job, they got sick, they got downsized, maybe they’ve gone through a divorce; they used credit to survive, and now they’ve got a bunch of debt that they can’t handle. And it’s a worry, because if you get behind on your credit cards and your bank loans and your income taxes, you’re likely to have your wages garnisheed, you’re getting phone calls at work, bank accounts can get frozen, a whole lot of nasty stuff can happen.

So people come to us, and we work out either a consumer proposal or a bankruptcy. And a consumer proposal is quite simple; we make a deal with the people you owe money to. So a typical person we deal with might have 40, 50, $60 thousand dollars of what we call unsecured debts, so not car loans and mortgages – we’ll talk about those on today’s show – but things like credit cards, bank loans, payday loans, income taxes, and you’re way behind on them. We talk to the people you owe money to and work out a plan where perhaps you pay 20 cents, 30 cents, 40 cents on the dollar back, no more interest.

So it’s a win-win for everybody. The people you owe money to get more money than they’d get in a bankruptcy, and you don’t have to go bankrupt. And again, we’re Licensed Insolvency Trustees, which means this is all governed by federal law. No one else can do this unless they have a license from the federal government.

And all of our consultations are free. So there are no up-front fees. And the reason there are no up-front fees is it’s illegal for us to charge up-front fees. That’s one of the conditions of my government license. You come in, you talk to us for free and we explain your options, and then you decide from there what’s going to work for you.

Dave Callander: All right. Now as you mentioned on the show, we’ve often talked about things like credit card debt, unsecured debts; I don’t know if we’ve ever focused directly on vehicles. So let’s start with cars. Why do people get into debt problems with their cars?

Doug Hoyes: Well because we like driving new cars and we like driving new trucks, and unfortunately they’re getting more and more expensive. I mean I’m an old guy Dave, I won’t say how old I am but I remember when I started driving there was no such thing as, you know, CD players in the car let alone GPS’s and rear-view cameras and backup this and backup that. They’re getting much more expensive, and as a result very few people today pay cash when they go buy a car.

And again, if you’re listening to the show today, ask yourself that question; the car you’re driving now, did you pay cash for it? Well if it’s a thousand-dollar car perhaps you did, but it’s very rare to see someone driving a brand new car that they went in and paid cash for. They get a loan to buy the car, or they lease it. And you know, again, we used to pay cash for everything but then we started getting car loans, and now cars are getting more expensive.

And so it’s not uncommon for a car loan to last for as long as eight years now. And these long loans are great for car sales, but unfortunately it’s very expensive for consumers. I mean you probably don’t know this, but in Canada automakers are selling about 41% of the vehicles they sell now with loans of at least six years or leases of at least five years. So that means you get a car, you get a loan to buy a car, and you will probably be paying for it for five, six, seven, even as much as eight years. And that’s great for car sales. I mean they hit a record for the third straight year in 2016. But about 85% of cars are bought with debt, according to DesRosiers Automotive Consultants. So you think it through.

Vehicles depreciate over time, and you know, I mean you drive a car off the lot, it’s worth a chunk less the very first day you drive it off the lot. And longer-dated loans, so five years, six years, seven years significantly increase the chance that you’re going to end up owing more than your car is worth.

And we know from reports that the share of Canadians – here’s another fact – the share of Canadians trading in vehicles with negative equity rose to 30% in 2015. And on average they were underwater by about, oh just under $7,000 Canadian according to J.D. Power. So underwater means my car is worth $10,000, but there’s more than $10,000 owing on it. And you know these are serious problems that we’re seeing.

Dave Callander: Tell me a little bit more about the kind of people you meet who have problems with cars and debt.

Doug Hoyes: Well the typical person I see would be someone who, they went to the car dealer – and again, I’ll ask the listeners to think this through. So when you went and bought your last car, did you say to the car salesman ‘How much does this car cost?’ Or did you say ‘What’s my monthly payment going to be?’ We tend to buy cars based on the monthly payment not the total cost.

And it’s also very common, as I said, a big chunk of cars end up with a shortfall at the end of the loan or the lease, so you’re buying a car but you’re bringing in the debt from the previous vehicle. So my old car, it’s now three, four years old, I want to trade it in, but I’m short by $5,000 or $6,000 on the loan. No problem.

So we give you the new car and we take the $5,000 you owed from the old one and put it on the new one. So I’m buying a $30,000 car, but I end up with a $35,000 loan. And of course, the moment I drive the car off the lot it’s only worth $25,000, or whatever. So there’s a shortfall built into it right away.

When people come to see me because they end up having to file a consumer proposal or go bankrupt, it’s quite common to see a shortfall of $10,000 bucks. In fact, I almost don’t have to ask someone ‘Oh you’ve got a car? You’ve had it for a couple years? Well you’re probably short $10,000.’ And by the time we do all the math, it’s very common to see that number.

And so then you get someone who loses their job or gets sick or get divorced, they’ve got this car, they’re underwater on it, and so what do they do? Well they’ve got no choice at that point but to file a proposal or a bankruptcy.

That was the first part of my discussion with Dave Callander about car loan debt. You can keep your car and keep paying your car loan if you file a consumer proposal or go bankrupt, but if you have a significant shortfall it’s often better to just surrender the car and include the shortfall in your consumer proposal or your bankruptcy.

This is a bit of a confusing topic, so Dave and I got into more detail in the second part of the show, after the commercial break. Here’s the rest of our conversation.

Dave Callander: To start things off, we’re focusing on debt surrounding cars. We all have to have one for the most part. Everyone drives here and there. And most of us, as Doug pointed out, love the shiny brand new cars, and that’s kind of where we get into problems. So, just a recap for folks who may have joined the show, what is the main problem surrounding purchasing cars and debt?

Doug Hoyes: Well the main problem is the cost. So you’re buying a car, and obviously when you buy the car there’s taxes, a whole bunch of other charges included in it. So the moment you drive a new car off the lot it’s worth less than what you just paid for it. So you buy a $30,000 car, whatever the number is, you end up paying $35,000 by the time you get all the taxes and this and that in it.

If you wanted to sell that car the very next day, you can’t get $35,000 for it. You can’t even get $30,000 for it, because anybody else can go and buy that brand new car for that price. Maybe you’re lucky to get $25,000 for it. And of course I’m making up numbers; these are rough numbers, but the math is pretty daunting on it.

Now if you keep the car right to the end of the loan term then you’re fine. The loan’s paid off, it’s all good. But it’s very common for the car place to phone you up and say ‘Hey’… And in fact this happens to me all the time. I get a letter from the place I bought my car, and I drive a 2011 vehicle. So I’m not driving a brand new car. It’s many years old. But I still get a letter from them every, you know twice a year, saying ‘Hey, we’ve got this special trade-in deal’, you know ‘trade in your car, we’ll get you a new one.’

Now I don’t have a loan on my car. It’s old enough there’s nothing on it. But if you’ve got a car that’s two years old and it’s like ‘Oh, I can get the newest thing, the shiniest thing’, I trade it in and what happens? I’ve got a shortfall on it. So there’s $20,000 left on the loan but the car is only worth $15,000. No problem.

The dealer says ‘We’ll take that $5,000 shortfall and we will roll it into your new loan. Now we’re going to sell you a $40,000 car.’ That’s great; well your loan is $45,000. And if you do that once or twice; in other words if you do that every couple of years, you’ve always got a shortfall.

So you’re never in a position where you can say ‘You know what? I’d like to reduce my costs by turning in the car’. You can’t do it because there’s always this big shortfall. And if that’s your only debt that’s fine, but of course the people we deal with at Hoyes Michalos end up having a lot of other debts as well, and it just compounds the problem.

Dave Callander: So what is your advice then if we’re thinking about getting a car loan?

Doug Hoyes: Well number one, it’s more than just the monthly payment. So a common sales technique for a car loan company, the car dealer, would be to say ‘Well what can you afford?’ And if the answer is ‘Well I can afford $400 a month’, ‘No problem, we’re going to find something that is $400 a month. Now it might end up being an eight-year loan in order for you to be able to pay for it, but ‘No problem, we can find something that will get you into that’.

I’m much more interested in what is the total cost I’m paying. So why don’t you start with that question. When you’re buying a car, ask the dealer ‘If I was to pay cash right now, cash, cash on the barrel head, how much would it cost me?’ And that’s a much more relevant number than ‘How much am I going to be paying every month?’, because of course the monthly payment can be adjusted up or down based on how long it runs.

You also want to figure out how much you can actually afford. So can you actually afford $400 a month? Is that realistic? So it might not be a bad idea to spend a few minutes before trotting off to the car dealership to actually crunch the numbers. Do a budget, figure out what you can realistically afford.

And again, people get caught on this all the time. It’s not just a payment on a car. You’ve got to pay insurance. And if you’re a 22-year-old male then your insurance is going to be a massive number. You’ve also got to put gas in the car. You’ve got to do repairs and maintenance. If it’s a brand new car with a full warranty, okay your maintenance costs aren’t going to be that great. But if it’s a used car, well guess what, cars need tires, cars need oil changes. So factor in all those costs as well.

So I’m a big believer in keeping your loan payment as short as possible. If you can pay cash fantastic, but at the very least keep the loan payment as short as possible. And one way to do that is to have as big a down payment as possible.

If you get into trouble, then talk to a professional about it. So as you said at the top of the show Dave, we are, at Hoyes Michalos, Licensed Insolvency Trustees. We can help make deals with your creditors to deal with these kind of issues.

Now I want to be very specific here. A consumer proposal or a bankruptcy deals with your unsecured debt. So it deals with credit cards, bank loans, Payday loans, even income taxes are included in a consumer proposal. A secured debt like a car loan is not dealt with directly in a consumer proposal. And a secured debt is a debt that is attached to something. So there is a car attached to the debt, that’s a secured debt.

So if you were to file a consumer proposal you can keep your car. A lot of people don’t understand this. As long as you continue making the payments on the car you can keep the car, no problem. The decision you’ve got to make is, does that make sense.

So go back to the whole thought process about the shortfall. I’ve got a shortfall on the car of five or $10,000, does it make sense to keep the car, keep making the loan payments, knowing full well that I’m going to be paying $5,000 or $10,000 more than the car is worth over the life of the loan.

Your choice if you’re filing a proposal or a bankruptcy is to say either ‘I’m keeping the car and I’m going to keep making all the loan payments’, or right at the start of the proposal ‘I’m going to surrender the car. I’m going to say to the car dealer or the bank ‘Here you go, here are the keys, it’s your car now.’’ And if they take the car and sell it before the proposal is up and running, any shortfall is included in the proposal.

So you can actually eliminate that date in the proposal or the bankruptcy if you are willing to give up the car. And this is a very difficult decision for people because I need my car to get to work. I mean in the Kitchener-Waterloo, Cambridge, Guelph area here there is no subway. You can’t take a subway to work, so a lot of people drive. And I guess, you know, the LRT will eventually be built and we’ll all be taking that, but at the moment cars are the way most people travel.

And so it’s a very difficult decision to decide do I give up the car or not. You’ve got to really crunch the numbers, but you’ve also got to look at what your options are. And so if your friend, family member has an old couple of thousand dollar car that they can sell you, in a lot of cases you’re better off doing that than trying to hang on to a vehicle that’s just going to put you deeper and deeper into debt.

Dave Callander: I’m glad you pointed this out because again, I don’t think we’ve ever really dealt with this directly on the show before. I had no idea that you could return the vehicle and make that shortfall part of the consumer proposal.

Doug Hoyes: And this is why you want to talk to a Licensed Insolvency Trustee up front, because we understand the rules. And these rules have evolved over the years. If you go back you know 10, 15, 20 years, it was not the way I’m describing it today. It used to be – and there was one bank in particular that always did this – if you filed a bankruptcy they took your car, no questions asked, that was it.

The government changed the law a few years ago to say that a secured creditor cannot cancel a secured contract – in other words a car loan – if your payments are up to date. So if your payments are up to date on your car loan when you go bankrupt or when you file a consumer proposal you can keep the car, as long as you keep making the payments.

But, is that the correct answer for you? And in a lot of cases no it is not the correct answer to keep an older vehicle with a big shortfall, particularly if you’ve got a lease that has a mileage clause in it. ‘Well I know I’m already 20,000 clicks over the limit.’ Okay, so when you return that vehicle in a year you’re going to get hit with a big charge. So in a lot of cases it’s better to say ‘You know what? Give the vehicle back now, find something cheaper.’

And yes, if you’re going to finance another vehicle right at the start of a bankruptcy or proposal – it’s possible. There are certainly car dealers in town who will do it, and you call our office at 310-plan, we can tell you who will do that. But often the deal is the first year you end up paying a pretty high interest, you know, could be 25, 30%. So you don’t want to be getting much more than a $5 thousand car loan. It’s huge. It’s huge.

But in a lot of cases, after the first year, you’ve made all your payments, well now it becomes a, you know, 10 or 15% loan. And by the third year you can often get back down to a much more reasonable rate. So in a lot of cases the better answer is to make the tough decision, get the fresh start and surrender the vehicle. But it is up to you; that’s the point.

Dave Callander: But the folks at Hoyes Michalos can help you crunch the numbers and figure out what makes sense for you.

Doug Hoyes: Absolutely. And I always recommend bring your lease documents in with you. Bring your loan documents in. We can go through it and figure out if there’s some kind of weird accelerator clause, a mileage clause, a penalty for breaking a lease, whatever. So we can tell you.

And we also have access to the Black Book, so we can punch it into our computer and tell you how much your vehicle is likely worth today. You could also go back to your dealership and get an appraisal from them; ‘Hey, how much cash would you give me for it today?’ And then you know for sure what you’re dealing with.

I don’t like making decisions without proper information. I like to know exactly what I’m dealing with. And that’s what we emphasis at Hoyes Michalos; let’s help you get the proper information, educate you so that you can make the right decision for you and your family.

Dave Callander: My guest today on Ask the Experts. We’re speaking with Doug Hoyes of Hoyes Michalos, Licensed Insolvency Trustees, online at hoyes.com. That’s h-o-y-e-s-dot-com, or call 310-PLAN.

Doug Hoyes: That was my interview with Dave Callander on the Ask the Experts show on 570 News, where I gave my advice on how to deal with car loan debt. My advice, well it’s more than just about the monthly payment. Figure out what you can actually afford. Keep your loan payment as short as possible. Have as big a down payment as possible. And if you get into trouble, get professional advice. That’s what we’re here for.

There are two big things in life we borrow to purchase, cars and houses. We talked about cars today, and next week I’m going to play the second half of my interview with Dave where I talk about houses. Real estate is a big topic at the moment, so you won’t want to miss that discussion.

That’s our show for today. Full show notes and a complete transcript of today’s show are available at hoyes.com; that’s h-o-t-e-s-dot-com. That was our discussion about car debt, so until next week when we’ll discuss mortgages and real estate I’m Doug Hoyes. Thanks for listening. That was Debt Free in 30.