Canadians may be buying more car than they can afford, and banks are making themselves vulnerable by allowing it, ratings agency Moody's said Thursday.

Car loans have increased from $16 billion in 2007 to $64 billion last year — an increase of 20 per cent a year, on average, Moody's said in a report Thursday. That's much faster than the growth seen in red-hot mortgages, credit cards and others loans, and reason for concern.

Low interest rates have combined with historically low new car prices to make car loans look a lot cheaper than they really are.

"Historically low interest rates have helped camouflage the financial picture of Canadian consumers, many of whom have become complacent about their use of debt," Moody's said.

Loans getting longer

Traditionally, Canadian car loans have averaged somewhere between about three and five years in duration. That's shot upward recently, however, with ultra long-term car loans becoming more prevalent. 

In 2009, less than 20 per cent of Canadian car loans were for longer than five years. Today, that figure is closer to 50 per cent. Overall, the average car loan is now five months longer than it was in 2009, Moody's said in its report.

That could be bad news for consumers. Consider the example of a 2013 Ford Escape. A theoretical buyer of that car would likely have the option of financing it at about four per cent if they didn't want to pay the entire $26,247 sticker price up front.

If that buyer took a five-year term to pay back the loan, he or she could realistically expect to be able to sell the car for more than they owe on it after four years — based on depreciation rates outlined on the industry-leading CanadianBlackbook.com which tracks used car values.

But that same buyer, taking an eight-year term to pay back the car loan, would still be underwater on the car six years after buying it — he or she would still owe more than $8,600 on a car worth about $6,300.

'Low interest rates have helped camouflage the financial picture' - Moody's report

"The treadmill can only end in one of two ways," Moody's analyst Jason Mercer said in the report.

"Either the consumer maintains the discipline to keep their vehicle until it reaches a positive equity position, or they can no longer sustain it and default."

That's bad for the car buyer, but it's also bad for the lender who financed the purchase.

Banks have made a booming business in lending to car buyers since the recession, with the aforementioned growth of about 20 per cent per year. Cheap-looking rates notwithstanding, all that debt adds up to real money that has to be paid back eventually.

The debt-to-income ratio of Canadians hit an all-time high of 166 per cent at the end of last year. That's almost twice as high as it was in 1992, the previous time Canada had as bad a recession as the one we saw in 2009.

Then, unemployment peaked at almost 12 per cent, and the total ratio of what are known as "nonperforming" bank loans hit six per cent. Bad loans for banks are currently a much lower percentage than that. But it wouldn't take much of an uptick in either unemployment or interest rates, the report says, to start a snowball that would end with the banks holding a lot more bad debt than they're used to. And the only collateral they've got to bridge that gap would be cars worth a lot less than the loans that bought them.

"For banks, it means [it] could result in significantly lower recoveries in the event of default," Moody's said.