Risks to consider when buying a car

Depreciation and negative equity

Cars lose their value, or depreciate, quickly. The value of a new car drops as soon as you drive off the dealer’s lot and it keeps decreasing over time.

By the end of the first year, your new car can be worth 25% less than the price you paid. Within the next four years, your new car will typically lose 15% to 25% of its value each year.

You have "negative equity" when your car is worth less than the amount you owe on your car loan.

Example: Long-term negative equity​

Two years ago, you bought a new car worth $31,300. You paid $3,700 in taxes and fees. The total cost of the car was $35,000.

You paid for the car with a $35,000 car loan with an interest rate of 4% for an eight-year term.​ Your monthly payment is about $425.

Table: Example of long-term negative equity
How long you’ve owned the car Depreciation
(25% after 1 year, 40% after 2 years)
Value of your car Amount remaining on your loan Amount of negative equity
0 years (brand new) $0 $31,300 $35,000 $3,700
1 year $7,825 $23,475 $31,200 $7,725
2 years $12,520 $18,780 $27,300 $8,520

*This example is for illustrative purposes only.

In the example above, after two years, your car would be worth $8,520 less than what you owe on your car loan. It takes longer to get out of a negative equity situation in a long-term loan.

Graph: Negative equity comparison on a $31,300 car with a 4% interest rate

Graph: Negative equity comparison on a $31,300 car with a 4% interest rate
Text version: Negative equity comparison on a $31,300 car with a 4% interest rate
Year(s) since purchase Value of car Loan balance (5-Year Term) Loan balance (8-Year Term)
1 $31,289 $35,357 $35,357
2 $20,139 $28,838 $31,530
3 $17,008 $22,055 $27,547
4 $15,205 $14,995 $23,401
5 $10,641 $7,647 $19,087
6 $9,021 $0 $14,597
7 $7,837 $0 $9,925
8 $5,236 $0 $5,061
9 $3,478 $0 $0

This example illustrates how a long-term car loan may extend the period during which you have negative equity. With a five-year loan, you have positive equity sooner. So the value of your car is higher than the amount you owe during the fourth year. With an eight-year loan, you have negative equity until the seventh year.​​

The financial risks of negative equity

If something unexpected happens and you need to sell your car quickly, you may lose money. If your car is worth less than the amount you owe on your loan, you might have to borrow money to cover the difference between what you can sell your car for and what you still owe on it.

If you get into an accident and your car can’t be repaired, the money you get from the insurance company may not cover what you still owe on your car loan​. For example, if your insurance company decides the replacement value of your car is $10,000 but you still owe $16,000 on your loan, you will need to cover the $6,000 left on your loan.

If your car is worth less than the amount you owe on your loan and you trade in your car to buy another, you may end up paying extra money. You might need to borrow to pay for the new car and cover the amount still owing on the old loan, which could add up to a larger loan and more interest charges. This could result in even more negative equity.

Risks associated with long-term car loans

Car loans with terms of 72 months (6 years) or more are considered long-term loans.

Pros and cons of a longer-term car loan

Before taking out a long-term car loan, compare the pros and cons.

Pro

Cons​

​Paying more for the same car

The total cost of the car will be higher if you choose a longer-term loan because of the interest you will pay over the loan's term. In the example below, you would pay more than twice as much in interest, increasing total cost by more than $2,700.​

Table: Example of interest paid on loans with different lengths
Price of the car Interest rate on the loan Term of the loan (months) Total interest paid Cost of the car with interest
$25,000 5.00% 36 $1,974 $26,974
$25,000 5.00% 84 $4,681 $29,681

*This example is for illustrative purposes only.​​​​​​​ Amounts have been rounded to the nearest dollar.

Buying a more expensive car

In the example below, the regular payments are identical even though the first car is nearly twice as expensive as the second one. In the case of the first car, you would need to ensure that you could afford the regular payments and all the other ongoing costs for twice as long and be comfortable paying close to $3,500 more in interest.

Table: Example of the total cost of loans with the same payment but different lengths
Price of the car Interest rate on loan Term of the loan (months) Regular payment Total amount paid
$29,775 5.00% 72 $479.50 $34,524
$16,000 5.00% 36 $479.50 $17,262

*This example is for illustrative purposes only.​

Reduce the risks of auto-financing

Here are some things you can do to avoid the risks associated with financing a car:

Related links

Page details

Date modified: