What you need to know about car finance
There are typically only two routes to owning a car - buying it outright with cash in hand or arranging finance that may or may not include a deposit from the buyer. Financing a car purchase means that you take credit from a lender to settle the seller. You are then liable to repay that loan on the agreed terms over a predetermined period of time.
At a dealership, there will be someone called an “F&I” on the shop floor. Short for “finance and insurance,” this person will act as a broker, arranging approval and taking you through all the details when financing a car. When a person buys a car through a private sale, many of the benefits of an F&I are now available online via Wesbank and others’ offers to finance private sales. One simply has to do a bit more legwork when financing a private car deal and the seller and buyer as well as the consultant handling the application will together perform the F&I functions needed to clinch the deal.
Financing Terms Explained
- Credit Rating - This determines, firstly, whether or not someone is eligible for a loan and, secondly, the extent of credit that can be extended. An aspect of life governed by law, a lender cannot extend credit to someone with a bad credit record as this is seen as reckless lending to the disadvantage of the consumer.
- Affordability - is something a lender will look at when a person applies for car finance. Governed by the same South African consumer protection legislation, a lender may not recklessly lend to someone who cannot demonstrate the ability to comfortably repay the loan, all things considered. A typical pre-approval sheet will ask for details about your current financial commitments, other existing loans and living expenses to determine affordability. Usually bank statements are needed to establish the regularity and extent of income, particularly for self-employed people. Other paperwork required includes an acceptable proof of address, a driver’s license and a certified copy of your personal identity card.
- Deposit - refers to a cash amount that might be required as a contribution to the purchase of your next car. Trading in your old vehicle as well as cash-back structures that a dealership can arrange based on their offers at the time can both often offset the need for a lump sum deposit. Make sure that if the deposit is avoided somehow and possibly worked into the monthly repayments, it doesn’t push the purchase into unaffordability down the line.
- Interest - is the amount you’ll repay on top of the loan amount a lender extends to you to finance the car purchase. This is how the bank makes money. Interest rates can be either fixed or linked. One can burrow down to squeeze the lender for the best possible rate, fix it at that number and then know that for the duration of the repayment period, one’s monthly repayments will be an exact, certain amount. This appeals to many as it avoids the fluctuations possible with a linked interest rate. A linked interest rate sees the interest repayments linked to the current prime lending rate. In good times, this is a great option, as one might benefit from reduced monthly payments if the Reserve Bank-derived interest rate drops. On the flip side, when interest rates go up, so does the monthly repayment, and you can end up paying more for the same thing simply because of broad economic inputs over which you have no control. A matter of personal preference, opting for a linked or fixed interest rate will depend on your risk appetite, although the range within which linked rates can fluctuate is typically small.
It’s important that in the initial signing of the deal, you get the lowest interest rate possible. Don’t accept the first offer - ask the person handling the finance application to shop around or otherwise squeeze for the lowest rate as it adds up over time. A bit of proactivity upfront can make for more affordable car ownership.
- Example - You buy a car for R100,000 that you borrowed from a bank. The interest rate is fixed at 15 percent per annum. That means you’ll have interest calculated monthly at a fixed rate of 15 percent to determine the monthly repayments for the loan period. Having a linked interest rate means that 15 percent fixed rate can dip to 12 or even 11 percent in the same period, making monthly repayments less. If the global economy or other domestic pressures push interest rates up, however, as the Reserve Bank attempts to manage currency value and inflation, you could end up paying 17 or 18 percent interest over the same term for the same goods. As a central bank raises rates, so do banks and other lenders raise their own rates accordingly. Something to consider.
- Repayment terms or period - This is the length of time over which you agree to repay the loan. Typical terms on offer in South Africa are between 12 and 72 months. Again a matter of personal preference and affordability, a shorter repayment term makes for quicker complete ownership of the car. A longer period enables much lower monthly repayments, however, and usually a balance between these two considerations is struck to meet both needs. Don’t forget that the longer a repayment agreement runs, the more interest you’ll finally pay on the loan. In a nutshell, paying a car off sooner rather than later costs less overall but taxes cash flow more than other options.
- Residual or balloon payments - are the product of structuring a car purchase in such a way that a lump sum is deferred as a final needed payment in order to finally own the car. As an example, let’s say you buy a car worth R200.000. An amount of R30,000 is allocated as a “residual.” This means that after completing loan repayments for the stipulated period, a final payment of R30,00 will be needed to finally close the loan arrangement and take ownership of the car. Deposits, monthly payments and other affordability issues can be happily lowered when employing a residual structure. There is also the prospect, however, that a residual structure can generate a false sense of security, as monthly repayments are artificially lower because a percentage of the purchase price has been removed from the contract’s repayment calculations. If you don’t think you’ll have the R30,000 in cash one day to settle the lender, rather avoid contracts based on residuals, as it does hold the prospect of getting almost to the finish line, only to have to sell the car to settle the credit agreement. That said, a residual can be refinanced as a loan amount so, if you feel that your credit rating won’t diminish between the time you buy the car and the month in which you make final payment, or if you are someone with the ability to raise a small lump sum when needed, opting for this structure can provide genuine affordability on a car that would be slightly out of reach without it.
There are limits to how much can be deferred as a residual or balloon payment, but the only valid for a car owner consideration is their own affordability. Usually, staying both within a genuine affordability and the shortest route to repayment are good tips to follow.
- NB: Although a residual amount allows for lower monthly payments, it is still factored into interest repayments and, over a hypothetical five year loan period, you very often end up repaying that amount in interest charges, yet are still faced with the need to pay over the R30,00 at the end of the repayment period. This might seem a false economy for some and it’s worth taking your time on this aspect of things when signing up for financing, so that you are completely comfortable with the outcome you’ve chosen.
- Mileage limits and the condition of the car are factored into a residual repayment plan. Often there will be limits on the acceptable condition of a car and annual usage (mileage) allowed, as now the lender is looking forward in time to a resale value to make the residual-structured loan viable. Since mileage determines resale value, as does current condition of the car predict future condition, these considerations make a balloon structured finance deal more complex and it’s important to be intimately aware of how they might impact on your personal use requirements of your new car. Insurance stipulations might also become less flexible within a residual loan as the lender now has a greater vested interest in the car.
Don’t be shy to ask about terms and conditions of the paperwork that leave you stumped. Buying a car for the average buyer is an infrequent occurrence compared to F&Is and regular sellers who are engaged in car trading every day. There is no need to appear well-versed in all of the jargon. Ask and ask again until a clear picture of all implications appears in your head and you know, honestly, that a car finance deal is going to enable you, not become a source of anxiety months down the line.