Dealership F&I departments are missing out on sales opportunities related to the negative equity held by Canadian auto consumers, industry experts say.
Negative equity occurs when the amount owed on a vehicle exceeds its value.
According to data by J.D. Power’s Power Information Network, quarterly averages for negative equity fluctuated between $6,830 and $8,354 per new-vehicle transaction in 2020. In the first quarter of 2021,
the average was $7,328, a 12-per-cent year-over-year decrease.
Robert Karwel, head of the J.D. Power automotive practice in Canada, said that negative equity fluctuates through the calendar year and is typically highest in the first quarter.
Because of the global microchip shortage hampering new-vehicle inventories and putting more pressure on used sales, “We’re expecting negative equity to trend down this year because people’s trade-ins are worth substantially more,” Karwel said.
Negative equity paves the way toward selling such products as extended warranties and guaranteed asset protection insurance — GAP insurance — said Hector Bosotti, national trainer for dealer training at Toronto-based Wye Management.
“A lot of F&I managers don’t even offer it,” Bosotti said. “Business managers just pick the low-hanging fruit. ... They’re making enough money just selling one or two items and not offering a full a menu of the protection plans that are available.”
In general terms, GAP insurance covers the difference between the amount owing on a vehicle and its valuation in the event of write-off, such as from a collision or theft. Without GAP insurance, the vehicle owner or lessee is on the hook for the difference, and negative equity can increase the exposure.
DEALERS MISSING OUT
The product offers high margins for dealers, Bosotti said, with profits per sale ranging on average between $500 and $2,000. Automakers’ leasing arms are also reducing the amount of GAP insurance being included in leasing arrangements, he said, meaning that consumers might not be aware that a loss greater than the list value of the vehicle might not be covered. However, few dealers are educating consumers on when they should consider GAP insurance and what it covers, an approach that could help make sales, he said.
“I can count on my right hand the number of F&I managers that actually produce any type of video vignettes on the need for [service contracts] and GAP coverage,” Bosotti said.
Service contracts form another key piece of the puzzle when setting up a long-term financing arrangement for a customer in a negative-equity position, Bosotti said. If the customer sees that a standard warranty doesn’t cover the period under which the amount owed on the loan is greater than the value of the vehicle, then that customer could be more inclined to purchase an extended service contract for a sense of security in keeping the vehicle longer.
Fewer than 15 per cent of customers return to the selling dealership for service once a warranty expires, Bosotti said. Extended service contracts play a role in retaining service business for a longer period, he said.
As an alternative to GAP insurance, some dealers offer a vehicle loss privilege program (VLPP). In the event of a total vehicle loss, the customer receives a similar payout to that offered through GAP insurance.
However, VLPP is not an insurance product. Instead, it is billed as a loyalty program in which the payout is a credit that can only be used toward the purchase of a new vehicle from the selling dealership. The customer can also choose to purchase additional protection for total loss, partial loss or theft in addition to negative-equity coverage.
“The challenge with the GAP insurance product nationally is that each province has different rules on how [dealers] can sell the product,” said Gurpreet Banwait, product manager for LGM Financial Services, which includes VLPP in its product portfolio.
“Whereas traditional GAP insurance would only cover that [equity] gap, this product can add additional benefits [and] the customer would come back to the dealership to replace their vehicle at that dealership.”
‘PEOPLE CAN HANDLE IT’
Negative equity peaked in Canada in the first quarter of 2020 when the average crossed $8,000 for the first time, Karwel said. The figures returned to a typical cycle for the rest of the year, with averages of $7,887 in the second quarter, $7,113 in the third and $6,830 in the fourth quarter, before rising again slightly in the first quarter of 2021 to an average of $7,328. Negative equity was a factor in about 30 per cent of transactions, which was slowly trending upward, Karwel said.
“It’s due to longer-term loans, and lower down payments, while customer trade-in cycles remain on relatively short time frames.
“To put it into perspective, five years ago, negative equity was 27 per cent.”
COVID-19 has had an impact, however.
“We are noticing trade-in values increasing, and down payments on new vehicles increasing, which both are good news to helping reduce negative equity now and in the future.”
While negative equity is persistent, “people can handle it,” Karwel said. Consumers understand that reversing negative equity simply means keeping their vehicles until the loans are no longer upside-down, he said.
With front-end profits climbing as transaction prices increase, dealers are currently heavily focused on those gains and could be missing out on F&I profit opportunities that go hand in hand with long-term financing, Karwel said.
The average transaction price in Canada crossed the $40,000 mark for the first time in December 2020, according to J.D. Power.
“A sharp dealer is going to still keep on attacking [their F&I office profitability] with the same vigour,” Karwel said, “even though they’re making more this year from the front end.”