Motoring / 11 November 2015, 08:49am / Motoring Staff
Johannesburg - If you’re entering a hire-purchase or lease agreement, do your sums and find out whether you can afford the monthly payments, and whether there’s any balloon or residual payment at the end of the finance term.
Balloon payment deals allow you to drive a more expensive car than you could otherwise afford, by letting you pay a lower instalment over the finance period but hitting you with a lump sum at the end – which you must either pay as a one-off or re-finance (paying yet more interest and fees), which many people cover by selling the car.
It’s important to remember that you do not 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.
More and more buyers, in both the new and used markets, are opting for finance structures that lower their monthly repayments. These include the use of large balloon payments (also known as residuals) as well as taking advantage of the longer repayment periods that banks started offering since the implementation of the National Credit Act (NCA).
HEAD vs HEART
“Consumers can sometimes be led by their heart, rather than their head when shopping for cars, but they should resist the urge to splash out and get a vehicle that is not in their price range,” says WesBank spokesman Rudolf Mahoney. “They should carefully consider the repercussions of structuring their deals simply to have lower monthly payments, because they will ultimately end up paying a lot more.”
When the NCA was introduced in June 2007, demand for balloon payments plummeted as more buyers opted instead for longer contract periods to help reduce monthly repayments. Since then, demand for balloon payments has grown by 60%. Presently, one in every five finance deals includes a balloon payment that equals roughly 17% of the finance amount.
In the same timeframe more buyers have also opted for longer finance periods.
DOWNSIDE OF LOWER REPAYMENTS
“Longer finance periods and large balloon payments will bring down monthly payments, but there are definite disadvantages,” says Mahoney. “Buyers end up spending a lot more on the interest over the longer period of the loan, and a balloon payment, also subject to interest, could attract even more charges should a buyer decide to refinance.”
There are two different types of balloon payments – known as ownership and non-ownership residuals. In an ownership situation, you are buying the car and are responsible for the lump sum at the end of the loan term. With non-ownership, the bank or lender still owns the car at the end of the loan period, and is also responsible for reselling it to cover the balloon payment. In effect, you are leasing the car from the bank. Make sure you understand which it is that you are agreeing to.
“There are benefits and drawbacks to both scenarios,” says Standard Bank Vehicle Asset Finance. “With non-ownership the lender is responsible for the balloon payment so you don’t have to worry about finding the money. But there might be certain restrictions you have to comply with, like a mileage ceiling on the vehicle to ensure the resale value.”
WesBank has three simple tips for potential buyers to consider when structuring their deals, to help them save money in the long run.
HOW TO SAVE IN THE LONG RUN
1) Avoid balloon payments
A balloon payment of 20% on a vehicle of R240 000 will result in monthly repayments of R4739.58 (over 60 months, at 11.5% interest). At the end of the finance term the repayments total R284 374.84, however the buyer will still owe a 20% balloon payment – or R48 000 – thus bringing the total price of the vehicle to R332 374.84.
If the owner trades in their vehicle, the outstanding balloon amount will be subtracted from the trade-in price. If the owner chooses to keep the vehicle they can pay the amount as a lump sum or finance the outstanding amount, thus incurring further costs.
For a finance deal with no balloon payment the same vehicle would incur monthly repayment of costs of R5 335.23 (over 60 months at 11.5% interest), resulting in a total repayment of R320 113.55 – or R12 261.29 less than the deal with a balloon payment.
2) Opt for the shortest possible repayment period
Consumers can also save in the long term by opting for shorter repayment periods. The same R240 000 vehicle financed at 11.5% interest over 72 months will result in a monthly repayment of R4686.88. The repayments will total R337 455.18.
However, opting for a 54-month contract will save a buyer R25 821.80, with monthly repayments of R5770.99.
Opting for a shorter repayment period also means that the deal amortises sooner. Buyers who make use of longer contract periods will have to wait longer before the outstanding financed amount is less than the vehicle’s market value.
3) Pay for more up front
Buyers can save money by opting to pay more up front. This includes a deposit payment as well as finance charges.
By paying a deposit on a vehicle a buyer reduces the capital amount financed by the bank, and will thus pay less in interest. It is possible to purchase a vehicle without a deposit, subject to approval, but any size deposit will help reduce monthly repayments, without the disadvantages of a balloon payment.
It is also advised to pay for any extras up front, to avoid paying finance fees and interest by financing these as part of the deal. This includes aftermarket accessories such as tow-bars, canopies, and bicycle racks.