A recent report from Edmunds in the U.S. is revealing the cracks left behind by a pandemic-battered automotive retail sector. Almost a quarter of trade-ins had negative equity, showing an “average amount owed on upside-down loans climbed to all-time high of US$6,458” in the third quarter of 2024, a rise from US $5,808 in the same quarter last year. “More than 1 in 5 consumers with negative equity owe more than US $10,000 on their auto loans…7.5 per cent…owed US $15,000+”.
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Back in 2019, we reported via JD Power that 30 per cent of Canadian vehicle trade-ins were in a negative equity position averaging -$7,051. Earlier this year, Canadian Auto Dealercited the March JD Power report that “the percentage of negative equity for new vehicles at trade-in…hovers around 43 per cent.” All of these numbers should terrify anyone contemplating buying more car than they can afford.
My lease was up two years ago. The residual was $15,000 — the amount to buy the vehicle outright. This judgement day is traditionally a dance between the lessee and the dealer and/or leasing company — especially if the customer isn’t buying another vehicle.
Stick with ‘em, they’ll suck up a few scratches and overlook the fact it might need tires; they make it back on the new ride you’re already embracing. Turn it in to walk away? Brace yourself for the invoice you’ll receive in a few weeks outlining every single thing that will distance you from the right-there-in-black-and-white residual number. Just when you think you’re out, they pull you back in.
Except: two years ago, due to the (surely) once-in-a-lifetime landscape of pandemic shortages and critically low inventory, the market value of my car at the end of my lease was $30,000. It’s like winning a lottery you didn’t buy a ticket for. I bought out the $15k.
It’s people like me who have contributed to the current used car inventory shortages, as all those prized three- or four-year-old vehicles remain in the original lessee’s driveways, or get sold privately. There is also the “missing million”, as Canadian Black Book’s Daniel Ross calls the mid-pandemic vehicles that were never made or sold as new cars. They subsequently never became trade-ins, meaning consumers have fewer choices in the used market. “Prices peaked in March of 2022, but wholesalers sat on used cars they’d paid high prices for, so the market correction in the used market really began in 2023.”
Too many consumers in Canada and the U.S. are driving vehicles whose loan balances eclipse their value: they’re underwater.
Traditionally, interest rates are cheaper for new cars and higher for used. The very unsweet spot for those who paid record highs for a used vehicle at a higher interest rate has become sticky: you now owe more than your car is worth. Longer and longer loan terms are compounding the problem. You pay less each month, but far more over time — and delay building equity.
You might be tempted to roll that negative equity into a new vehicle. A dealer can legally finance up to 140 per cent of what you’re about to spend on a new car or truck. Lots and lots of room to cram in extended warranties, rustproofing, tinting, tire protection…and negative equity. Make yesterday’s tough decision go away.
It doesn’t go away.
Consider if your car is stolen or written off in a crash, or is on the news as its swept away in the next climate disaster. Your car goes away, but your loan does not. Debbie Arnold, a broker with Sound Insurance says, “for new vehicles, the client would/should purchase OPCF 43 Limited Waiver of Depreciation. This will offset depreciation applied at the time of loss. The carrier will pay out based on the bill of sale.” This coverage can only be applied to new cars and usually lasts for 24 to 36 months depending on the carrier. You can also purchase coverage from a separate company like Optiom, which covers cars less than ten years old.
A different option: at the time you purchase your vehicle, you can buy Guaranteed Asset Protection (GAP) insurance from the dealer. It can be pricey, but in the event your car is stolen or written off, it covers everything your car insurance doesn’t. It pays off the balance of your loan, regardless of whether that loan is comprised of rustproofing or negative equity from a previous car. The whole loan. If you have financed above the value of that vehicle, you really want to consider this insurance. Car insurance covers the car; GAP insurance covers the loan and can be purchased for new or used vehicles.
Colin Brown is the sales manager at Hamilton Hyundai. “GAP insurance is very good for people who have put down little or no down payment, and have also rolled other costs into their financing, like warranties or negative equity from a previous loan.” If you finance the full cost of your vehicle, you are already underwater until your payments catch up to your depreciation.
Brown provided a recent scenario. A customer was trying to get out from under RAM 1500 they could no longer afford. They downsized to a much smaller vehicle in an effort to wrestle the debt, and put GAP insurance on the second vehicle. The second vehicle was totalled in a crash — not a great thing to experience, but as he says, “all the things went away. All the loan on the RAM, everything.”
Brown admits that most people should just ride out the underwater term in the original vehicle if they possibly can. “Sometimes all that happens is they end up with a monthly payment that is only slightly cheaper than the original one and they’re driving a car they have settled for.” One of the worst cases he’s seen? “The $100,000 Toyota Avalon,” he says. A slick salesperson kept selling the payment — rather than the vehicle — to an uninformed customer who kept chasing a shiny new car and consecutively rolled negative equity into yet another loan. Don’t be that customer. I’d also say don’t be that salesperson, but that would be naive.
Shari Prymak at Car Help Canada forwarded the following case on his desk, as if to prove my point: “$14,000 negative equity being rolled into a new loan for a total of $95,000. At 5.13% over 84 months, that’s a total borrowing cost of around $115,000. Not to mention that the dealer lowballed this consumer on the trade-in value and sold them $6,000 worth of overpriced add-ons. $2,000 rust module worth $100 and $3,900 extended warranty plan.” The only part of this summation I don’t agree with is the rust module being worth even $100: they’re a total scam, and worth nothing.
Maybe you just want to get out of your current vehicle and into a newer one. The problem? The number the dealer is offering you on trade, or even what you could get if you sold it privately, is not enough to pay off what you still owe on your car loan. Here’s where you have to resist becoming a statistic from the top of this article. A dealer is happy to finance, again, up to 140 per cent of the value of your new ride. Don’t do it.
The best time to buy a used car was in the last year, as retail prices finally started to follow wholesale prices on a downward trend. But that looming hole in the market — the missing lease returns and the missing million — means used car prices aren’t going down much further for the next few quarters.
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