Buying a car – new or used – is like navigating a road full of potholes. Speed and lack of caution will cost you dearly. In assessing what you can afford, you need to consider your “mobility cost”, not just the purchase price. Mobility cost includes your monthly repayments plus insurance, maintenance and fuel costs: some cars are far more expensive to repair than others, which drives up the cost of insurance too. And some cars are less fuel-efficient than others.
When interest rates are low, as they are now, the cost of paying off a car can constitute less than half of your total monthly mobility cost. So you need to factor in the cost of fuel and insurance when choosing a car.
When it comes to financing a car, you have three options: instalment sale agreement, leasing and rental. The route you go will be determined by what you can afford and whether you want to own the car or pay for the use of it, Jan Kleynhans, the head of vehicle finance at First National Bank (FNB), says.
1. Instalment sale agreement
A straight instalment sale agreement allows you to buy a car from a dealer or a private seller and pay for it in equal monthly instalments (including interest) over a fixed term. The term can be from 12 months to 72 months. The bank or credit provider owns the vehicle until it has been paid for in full. When the final instalment is made, according to the contract, ownership passes to you.
Wessel Steffens, head of vehicle and asset finance at Absa, says 72 months is the maximum contract period of an instalment sale agreement in the industry. He says affordability is the main driver behind the “ever-increasing term”. If you stretch the term of your loan, this will reduce your monthly instalments – but it will also cost you more in interest.
2. Instalment sale with balloon payment
An instalment sale agreement can be structured to include a “balloon” payment. A balloon payment is a lump sum that constitutes your last payment in the contract. The balloon payment is typically 30 percent of the purchase price, but can be higher if the term of your deal is shorter than 72 months.
Steffens says instalment sale agreements with balloon payments might make your instalment more affordable or enable you to buy a “smarter” car than you could afford if you bought by way of a straight instalment sale agreement, but the downside is that you defer payment of a large sum of money to the end of your contract, and you will pay more in interest. It’s vital that you understand fully the deal that you are entering into, especially one that includes a balloon payment.
“A balloon gives relief on your monthly instalment, but it’s expensive from an interest point of view, and it reduces amortisation – meaning the payment of capital. If you can afford to buy on a straight instalment sale, you are better off,” Steffens says.
There are risks associated with deals that include a balloon payment, Kleynhans says. You may not be able to sell the vehicle or trade it in at the end of the period to cover the balloon payment. This can happen if the vehicle has been involved in a serious accident, which can reduce the value of the car, or if you have clocked up high mileage or exceeded the mileage limit set in the credit agreement.
“If you aren’t able to come up with the lump sum at the end of the term, your bank or credit provider may be willing to enter into another credit agreement with you to enable you to pay off the balloon payment, so that you can take ownership of the car,” Kleynhans says.
Steffens says that deals that include a balloon payment are usually structured so that if you trade out of the deal – trade in the vehicle for a new car – between months 40 and 42, you won’t make a loss, provided you have looked after the car. In other words, the car should fetch enough to cover the outstanding balance and the balloon payment.
3. Lease agreement
When you lease a car through a bank (some vehicle financiers only offer leases to businesses, but the banks offer them to individuals), you pay monthly instalments in exchange for full use of the car during the lease term, subject to certain restrictions.
Typically, these restrictions include a limit on your mileage and that you return the car in a good condition, fair wear and tear excluded.
At the end of the lease term, you may:
* Return the car to the lessor (the bank);
* Buy the car from the lessor; or
* Renew the lease agreement.
Steffens says that since the introduction of the National Credit Act (NCA), pure leasing agreements have become scarce. A lease agreement may or may not be a credit agreement. If ownership passes to the consumer at the end of the agreement, it is a credit agreement.
Simone Monty, a partner and the head of consumer credit at law firm Hogan Lovells, says there was a proposal in an early draft of the National Credit Amendment Bill to change how the NCA defines a lease. The proposal contemplated removing the requirement that ownership of leased goods must pass to the lessee in order for the lease agreement to be regulated by the NCA. However, a later amendment to the bill, published in October last year, omitted that change and the definition of a lease remains the same.
4. Renting
If the hassle of owning and maintaining a car is too much for you, renting one from a car rental company might seem an attractive alternative. For people with an impaired credit record, it may be their only option. The biggest downside of renting is the expense.
For example, renting a VW Polo from Avis would cost you between R5 820 and R6 510 a month, depending on whether you go for 90 percent or 98 percent insurance cover. This means that if you are involved in an accident, you would be liable for up to R20 000 or up to R4 000, respectively. And Avis’s cover does not include tyre and windscreen damage – this will cost you an extra R20 a day.
You are liable for returning the car to the rental company in “good condition”, so if you exceed any agreed mileage restrictions, or the vehicle is not deemed to be in a good condition, you will be liable for restoration and excess mileage costs, which are usually levied at a rand-per-kilometre rate.
The NCA does not govern rental agreements, because extension of credit does not form part of the deal.
EXAMPLE: INSTALMENT SALE AGREEMENT WITH AND WITHOUT BALLOON PAYMENT
With balloon: You buy a car that costs R200 000 and finance it over 72 months at an interest rate of 12 percent and opt for a 30 percent balloon payment. It will cost you R3 416 a month (including an administration fee of R57) for 71 months, with a balloon payment of R60 000 (30 percent of R200 000) in month 72. You will pay R305 974 in total.
Without balloon: If you buy the car by way of a straight instalment sale agreement, without a balloon payment, it will cost you R3 989 a month (including the R57 fee). This is R573 more each month than if you had a balloon payment, but you would end up paying R18 743 less in interest, and you would not be liable for the R60 000 lump sum at the end of the term. You will pay R287 231 in total.
INTEREST RATES AND CHARGES ON VEHICLE FINANCE
In terms of the National Credit Act (NCA), an instalment sale agreement falls into the category of “credit facility”, meaning you can be charged interest of up to 22.1 percent (the repo rate of 5.5 multiplied by 2.2 plus 10 percent) a year.
“The rate offered is determined by the credit profile of the applicant and the asset, which explains why you may qualify for a certain rate on one asset and a different rate on a different asset. The risk is assessed and the deal is priced accordingly. Customers who manage their credit well will be rewarded,” Jan Kleynhans, the head of vehicle finance at First National Bank, says.
Wessel Steffens, head of vehicle and asset finance at Absa, reiterates this: “We score customers on the basis of individual risk, so the better your credit profile, the better the interest rate we can offer you.
“The rate is dependent on the overall risk assessment; it will not necessarily be higher if you are financing a used car,” he says.
When you accept vehicle finance, you may opt to pay a variable interest rate (which moves up or down in line with the prime lending rate) or a fixed interest rate (which is an agreed interest rate for an agreed term). “There are some real benefits to fixing your rate: it allows for fixed budgeting and takes some of the volatility out of the equation, but it comes at a price. This is because the funding that we obtain to provide fixed rates is expensive,” Steffens says. “Understand the difference between a variable rate and a fixed rate, and shop around for a good fixed rate,” he says.
Kleynhans says you need to take special care when choosing to fix your rate, because it cannot be changed for the duration of the contract.
You will be liable for a once-off initiation fee of R1 140 (including VAT) for initiating the credit agreement and a monthly administration fee of no more than R57 (including VAT).
Your bank or credit provider may also insist that you have credit insurance to cover your debt in the event of your death or disability, but it cannot prescribe the credit insurance provider. It may also insist on you taking out short-term insurance to cover the loss or damage to the vehicle in the event of an accident or total loss. Again, you have the right to choose your own insurer, provided the policy of your choice is reasonable and adequately covers the risk.
With an instalment sale agreement, with a balloon payment and without one, you can pay more than your monthly instalment when you can afford to. In this way you can reduce the term of your credit agreement and make significant savings in interest. But you cannot access any extra money that you have paid in – to use on a rainy day – as you can do with your home loan.
You can settle the whole amount owing at any time, and you will not be charged a penalty fee if your vehicle finance was for less than R250 000 and your credit agreement is governed by the NCA. Penalty interest may, however, apply for amounts of more than R250 000. You need to give your bank or credit provider notice of 90 days to avoid being charged the penalty.
“The smart thing to do is to use any extra money, such as a bonus, to settle your debt early, to reduce the interest that is charged on the principal debt,” Steffens says.
DEFINITIONS
A balloon payment is a lump sum that you pay to the bank or credit provider at the end of your vehicle finance term – in other words, you defer payment of a large amount to the end of your term. Having a balloon reduces your monthly repayments and makes the vehicle more affordable. Paying the balloon amount to the bank is entirely your responsibility, so you need to be certain that you will be able to sell the vehicle or trade it in at the end of the period to make this payment. You could also ask the bank to re-finance the outstanding amount (balloon) – that is, apply to borrow the money from the bank.
A residual payment applies to rental agreements only. The residual value is the credit provider’s estimate of what the vehicle should be worth at the end of the contract period. If you rent a car and a residual payment applies, when you return the car to the credit provider you will be responsible for any costs for restoring the vehicle to a good condition. “Residual” therefore refers to a lump-sum amount that may be due at the end of the contract, but the credit provider carries the risk for this amount.