Balloon payments blow up in one's face

IOL mot jun29 baloon payment pic2 AFP

Car financier WesBank announced this week that the number of South Africans who opted for balloon payments when financing their vehicles had dropped dramatically in the past four years - from 22 percent of car buyers in July 2007 to just 9.5 percent in June 2011.

A balloon payment - also referred to as a residual - is “an agreed inflated final payment of a loan that is paid in full at the end of the loan agreement”.

Essentially what this arrangement does is enable someone to live beyond their means - it lowers the monthly repayment to a sum a person can afford, prolonging the pain of a big final amount to be paid at the end of the repayment term.

Some first-time car buyers focus only on the monthly instalment, and fail to grasp the significance of the balloon payment.

And before the National Credit Act (NCA) forced credit providers to go big on disclosure in mid-2007, many consumers were not properly informed about how a balloon payment deal worked.

The result was that, just when they thought they’d paid off their car, they were alerted to the outstanding balloon payment, and in many cases they didn’t have the cash and their credit status had diminished to the point that they couldn’t finance it, either.

The NCA did a lot to protect consumers from walking “blindly” into a balloon deal, making it compulsory for this large “final payment” to be highlighted in advertising.

According to Chris de Kock, head of sales and marketing at WesBank, the movement away from balloon payments indicates that local consumers are becoming more aware of the structure of their finance deals as well as demonstrating better credit sense by buying within their means.

“The introduction of the NCA in June of 2007 has also been a major factor in the steady drop in balloon payments,” De Kock explains.

“The NCA allows for longer-term contracts and customers, who would have purchased with a balloon payment in order to make their dream car more affordable, now have the option of paying the vehicle off over a longer term without a balloon payment, where the repayment is roughly the same.”

So whereas the average contract period pre-NCA was 50 months, it is now 66 months.

De Kock warns that a balloon payment will take longer to reach “break-even”, which is the point at which the amount owing on a vehicle is equal to what the vehicle can be traded for.

“For example, a vehicle financed over 72 months with no balloon payment would break even at 44 months; but with a 20 percent balloon payment it would only break even at 58 months,” he said.

“Also, a vehicle financed over 72 months with a 10 percent balloon payment will increase the consumer’s interest cost by 8 percent.”

That’s quite a whack.

Clearly, many consumers don’t have the final lump sum available to make that final payment - De Kock says about 65 percent of WesBank’s customers on balloon payment deals ask for that final payment to be refinanced.

I’ve had quite few e-mails this year from people who signed balloon payment deals in 2006, before the NCA kicked in, and claimed to be oblivious to that large final payment requirement until this year, when they thought they’d paid off their cars in full.

“I bought a vehicle from a dealership in 2006 and it was financed,” wrote Phumzile. “It was supposed to be paid up on January 25, but the problem is I was told that I have to pay a residual amount of R34 000, which I don’t have.”

Bongani wrote: “I am in a dilemma here. I bought a Toyota Yaris sedan in 2006 and for some reason, probably my stupidity, I signed for a residual of R30 000.

“The end of the term is getting closer and there is no way I can raise that money. My worry is I might lose the car.”

Many want to refinance the balloon payment, but no longer qualify for a loan, so they are forced to sell the car to settle the debt.

Fazel went under debt review while paying off his car, and at the end of his four-year repayment term, he didn’t have the R52 800 balloon amount. And given his debt review status, he was barred from borrowing money to pay it.

Bottom line - read your car finance documentation very carefully before you sign, paying particular attention to the repayment section, specifically any reference to a final payment. Try to avoid a balloon payment deal if possible. - Pretoria News

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Anonymous, wrote

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04:46pm on 29 June 2011
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Phumzile and bongani are dom!

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steven, wrote

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02:10pm on 29 June 2011
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if you can't read a contract, then maybe you shouldn't buy a car

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Pauline, wrote

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01:44pm on 29 June 2011
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Breathe in, breathe out people. If yo ubuy a car holding reasonable value and sell it for more than the settlement amount, what is the big deal? I have always used balloon payments and have never lost money. I do not want ownnership of the car, I do not want to keep it for 5 years and the businbess use is tax deductable.

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Brendon, wrote

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01:13pm on 29 June 2011
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Balloon payment is the worst thing ever. Although your repayment is less, you are still charged interest on the outstanding amount. Therefore it costs you far more than buying the car on a straight deal. Also the 2nd thing I’ve learned is to finance the car over the shortest period possible. The only people benefitting from a balloon payment is the banks.

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jason, wrote

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01:05pm on 29 June 2011
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Some readers dont get it. For those who actually want to stay in debt indefinetly and just want to keep tradeing in their car every 48 months - this is a good solution. They will just keep paying forever increasing premiums. But for those thinking ahead it is better to buy cheaper and to pay it off in full as soon as possible. I still say a car is a luxury and you don't borrow money to buy luxuries. Maybe borrow for your first car, but then you pay it off in 60 months and use the next 60 months to save for your next one. So you buy something you can keep for 10 years - i.e. no fashion statements, but something that will last.

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Punk, wrote

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01:03pm on 29 June 2011
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People are blowing this out of proportion (i'm sure i saw corruption in the private sector thrown in here somewhere??). First up I agree that the NCA has helped with salepeople now being forced into making the customer aware of the lump sum payment due at the end of the contract. However, i dont see the point of treating residual deals as the devil? Some people change their cars once every 10 years - for them this sort of structure would not make any sense. But you do get people who want the latest car now. People just need to do their homework - if you intend on selling your car at the end of the term, you can structure the finance such that the residual is less than the expected trade in value of the car. That way you can get the money from the trade in, pay off the residual and have a bit of a deposit for a new car. and for those of you who believe cars are investments - unless you are buying a limited edition ferrari, they are not. The days of owning a car for 20 years has long past. So who cares if i own my car - fact of the matter is, i drive it :)

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Ashely, wrote

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12:54pm on 29 June 2011
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@Anonymous: If thats the case then, I guess I was taken for the fool aswell (or didnt read the fineprint) :P I was under the impression that the dealership finances the residual. (An I owe you as such)

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Anonymous, wrote

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12:21pm on 29 June 2011
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@Ashley: My understanding is that the Baloon payment is only worked out after interest is calculated over the full term. You actually lending the money over the full period(your case 4 years)...

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Thulz, wrote

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12:09pm on 29 June 2011
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The best thing to do is to trade in the vehicle for a new 1 but not making the same mistake again.

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Anonymous, wrote

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11:30am on 29 June 2011
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South Africans do not want lower prices. They want the latest cars with the latest gadgets and they will pay the price that the manufacturers put on their vehicles. People did not struggle so that they can get to drive a budget car.

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ashley, wrote

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11:03am on 29 June 2011
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I was under the impression the only reason you take a ballon payment (as I have) is that you never intend on keeping the vehicle, instead opting to trade it in and buy a new one at the end of the initial finanace period (4years in my case). Why would I want to own a vehicle out of warrentee, even more so...why pay interest on an extra year or 2 of the total cost that I dont plan on owning the vechicle for... This article is missleading in my oppinion, just the bank wanting you to finanace the full amount, for longer term so they can earn more interest.

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Sean Redmond, wrote

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11:00am on 29 June 2011
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We bought a budget CAR for cash. Never been happier, a little 1.1, does 140kph no problem, Get from A to B as quick as the Porsche.

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Dumi, wrote

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10:59am on 29 June 2011
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There's somuch CORRUPTION in the private sector as well, we all going to Hell good people..

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Anonymous, wrote

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10:58am on 29 June 2011
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I believe that selling a vehicle on residual to the ordinary man in the street should be outlawed. The only winners are the banks and the car dealers. I am surprised that this practise was not banned when the NCA came into effect.

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The bigger issue, wrote

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10:50am on 29 June 2011
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The bigger issue, of course, is that cars are excessively overpriced in South Africa. We have all seen how much more inflated our car prices are compared to other countries. And to add insult to injury, we in South Africa NEED cars because of the lack of proper transport infrastructure. Car prices need to be addressed, then baloon payments would not be necessary.

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Tom, wrote

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10:25am on 29 June 2011
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Balloon payments can work if you have declining interest rates over your finance period, as your monthly repayments will reduce more than a straight amortizing loan. However the reverse is true in a rising interest rate environment. My concern is that dealers don't explain the effect of the increased duration to potential clients, they want to close the deal. Given were rates are at the moment, taking a balloon payment loan now is extremely risky.

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rein, wrote

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10:17am on 29 June 2011
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If you can't refinance R34000 then there is a problem. Though I bought my car on a residual too and just late last year refinanced the residual amount adding another R40000 of interest on the amount. Hey who knew I'd be able to afford a Porche in 7 years time if I could only force myself to put the money away. At least I took my car on a 48 month term with the residual and when the term concluded I refinanced it again but this time on a fixed interest rate with no residual. And because it's a Mini Cooper it keeps it's value better than most cars. Just to give myself a sympathy pat on the back I think of it differently. I'm now drive a Mini that's less than 5 years old with only 80000 on the clock and paying a fixed monthly installment which ends up being the same amount that I would end up paying on a new entry level small hatch. Yay! I win! Or really do I now...

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Anonymous, wrote

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10:10am on 29 June 2011
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I bought a car with ballon payment I realised that after 2 years when i went over my contract, common sense prevailed if i didnt have R40 000 when i bought the car in the begging where will i get it at the end, sold the car and bought a new one without residual payment and i paid a R1000 more for 60 months....dont try to keep up with the jones if u cant afford u'll lose a lot of money and never have a car to show t the end of the day, u'll only have a bad credit record.

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Anonymous, wrote

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10:06am on 29 June 2011
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This story is the most misleading I have read in a long time, well done Mr De Kock nothing like selling an idea that makes the bank more money, the two cases in the above article are both of people who's affordability has dropped and not of people wanting to replace their vehicle. Please check your stats and see how many car buyers keep their vehicle to term?

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DAVE, wrote

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09:52am on 29 June 2011
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From day 1 , i knew this was a bad idea, often the outstanding amount(final payment) is more than the value of the car. The thing that the finance companies wanted was for you to trade in your vehicle and take out another reidual on your new car. The net result i that you pay forever for a new car that you will never own. It should have been banned from the outset. Maybe that kind of finance is more suited to business, operating a bit like a lease.

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