Cape Town – So you've seen your dream car advertised at an enticingly low monthly installment and you're wondering what's the catch. Chances are it's a deal with a balloon payment tacked onto the end. These sneaky deals can put you into a fancier car than your bank balance strictly allows, but before you jump into that sweet-looking deal, make sure you know all the twists and turns of this financial road.
When you take out vehicle finance the bank pays for the car and you pay the bank back over a period of time, with a whole lot of interest added to the original debt, to make it worthwhile for the bank. Trouble is, the payments are high because you’re paying off the original loan (the principal) and the interest at the same time, which limits how much you can spend on your new wheels.
So the banks have invented an attractive-looking way to let you drive a more larney car for the same monthly payment, by deferring part of the principal until the end of the finance period.
That way you’re only paying the interest and part of the principal every month, which makes it much more affordable – but at the end of the contract you have to come up with the rest of the principal in one huge cash payment – the residual or balloon payment.
Let’s put some numbers to that:
It’s bonus month, so you have an extra R10 000 you can put down as a deposit, and you’ve worked out that you can spend R4000 a month on your new car. According to WesBank’s Repayment Calculator, you can buy a nice little mid-level hatchback for R180 000 and pay it off over 60 months at 13.5 percent interest, and the monthly payments will come to R4007.62.
But you don’t want to be seen driving a ‘nice little mid-level hatchback’; you’ve got your heart set on a hot hatch that costs R260 000 – or R5848.40 a month. Ouch. Not gonna happen.
Then the salesman at the dealership suggests that you finance it over 72 months with a residual payment of 40 percent – that way the monthly payment will be only R4232.23. Okay, it’s R230 a month more than you budgeted for, but you can swing it, and a couple of days later you drive out of the dealership in your funky new wheels.
But here’s the kicker:
Six years down the line, you have to come up with a lump sum payment of R104 000, which is about what your six-year-old hatchback is worth, providing you’ve looked after it. Or worse. Your car could have depreciated below that point, in which case you'll end up owing the bank even after you've sold the car.
But there are two different types of residual-payment finance deals: ownership and non-ownership residuals.
In an ownership deal, you’re responsible for that R104 000, come what may. Either you’ll have to refinance the residual, which will cost you R3638.29 a month over 36 months – that means your R260 000 car will be nine years old by the time you’ve finished paying for it, and it will have cost you a grand total of R435 699.
Or you can sell it to pay for it, which gets you out of debt but leaves you without wheels, or you can trade it in on a new car and start all over again.
If however, the deal you signed six years ago was a non-ownership residual payment contract, the car goes back to the bank, and it’s their problem to sell it on and recoup the R104 000 that the car still owes them.
In effect, you’ve been renting the car for six years and, once again, you’re out of debt – but without wheels. There might also be certain restrictions you have to comply with, like a mileage ceiling on the vehicle to ensure the resale value.
Status comes at a price
Balloon payments have a place – especially if you have a large family and need a bigger car than you can afford to pay for, or if your business needs a van or a bakkie that’s above your cash flow.
It's important to remember that you don't have to go through the bank of the car dealer's choice. You can ask for different quotes from other banks and you are in a position to take the best deal for you, not the dealership.
But it’s a very, very expensive way to drive a status car that you really can’t afford. So, before you sign on the dotted line, make double-sure you know whether this is an ownership or non-ownership deal, and work out exactly how you’re going to cope with the lump-sum payment when the balloon goes up at the end of the finance period.
Or better still, go with the R180 000 mid-level hatch, add a set of fancy rims and a decent sound system, and drive a cool car that won’t bite you in six year’s time.
The golden rule is to make sure that you do not spend more than you can afford.