As of July 12th, 2017 – the Bank of Canada has announced that the prime interest rate will rise from 0.50% to 0.75%. This marks the first time that the Bank of Canada has raised the interest rate in nearly 7 years. September 8, 2010 was the last time Canadians saw a hike in interest rates.
What does this mean for people seeking an auto loan or who have existing loans? There are a few scenarios that we as Canadians should be aware of.
Seeking an auto loan
If you are seeking a new auto loan, the interest rate will be marginally higher now that the prime rate has gone up. To offset this, a lot of economists have suggested that consumers will trend towards longer term loans. Five year terms used to be the average, but recently, more and more people are going with longer terms as dealerships and financial institutions are offering six, seven, and eight year options.
Going with a longer term means smaller monthly payments which is a positive, but it does come with negative consequences as well. For example, if a consumer purchases a vehicle on a 5-year term vs an 8-year term, they will not see positive equity in the 8-year term loan until roughly 80 payments have been made, or seven years have elapsed. Whereas with the 5-year term loan, positive equity will start around year three, or 36 payments. Again, the problem here is that people are more intrigued by lower monthly payments than the long-term benefit of saving extra cash through a shorter amortization period.
This is especially important for people looking to sell their vehicle, or get out of their car loan early. In 2015, approximately 30% of Canadians who traded in their vehicle for a new one had negative equity, meaning they will carry debt over into their next loan. This can turn into a vicious cycle, and as your debt grows with a higher interest rate, the more you will pay in the end.
Another negative consequence to having a longer term loan is that you will have a higher chance at defaulting on a payment. Think about it, having less payments will give you less of an opportunity to make a financial mistake and eventually harm your credit score.
Existing fixed rate loans
Good news is that if you have a fixed rate loan (and you most likely do), that your rate will be unaffected by the interest rate hike. Most people who have auto loans have a fixed rate payment plan in place.
Existing variable rate loans
Although most car loans have fixed interest rates, there are some people who have elected to go the variable route. It is less common, and unfortunately there are some negative consequences since the rate has gone up.
Luckily, if you have a variable rate car loan, your monthly payment should stay intact and not increase. The problem is, the duration of your loan will. In the end, you will end up paying more as your payment duration will go up.
The auto lending market is very competitive
Even though the Bank of Canada has raised the interest rate, some lenders might absorb this extra cost to keep a competitive edge on their market share. Since 2013, Canadians have been buying cars off the lot at an emphatic rate, breaking monthly records. Lenders who are able to take on this extra cost will expect to continue to move more volume to offset the higher price.