There are so many options for financing a vehicle that consumers could be forgiven for getting confused by all the car-finance jargon. In this article, Alan Quinn, who has plied his trade in the finance industry for 20 years (during which time he worked for Accenture, Discovery, FNB and Wesbank), explains the various kinds of vehicle finance, as well as some of the most commonly used terms associated with them.
There are many ways in which to finance a vehicle and we will explain them in detail. Car buyers are often confronted by hard-to-understand words, which can cast doubt over their decisions, especially if they later fall foul of hidden costs. With budgets becoming tighter, it’s particularly important to ensure you get the right deal. Herewith is a list of the most popular vehicle-finance options and how they work. We also discuss “leasing” or “rent-to-own”, which are growing in popularity. Armed with this information, you could get your next car without any surprise shocks.
Most vehicle finance is an ‘Instalment Sale Agreement’
The “vanilla ice cream” of car finance agreements are called instalment sale agreements, because they allow you to pay off your car loan in equal monthly instalments over a number of months. These car loans can span between 12 and 72 months, but most are 60 or 72 months. The longer the term of the car loan – the lower your monthly instalment will be. However, the amount of interest that you’ll be charged on the loan will add up – so much so, that the sum you’ll pay back to the bank will be high. The best course of action is to try to pay the car off as quickly as possible. Think of it like this: a 60-month agreement is like one scoop of ice cream and 72 months is like 2 scoops. That extra scoop is enticing, but it has double the calories!!
Monthly payments can be reduced by putting down a deposit and/or taking a balloon/residual. Banks will calculate your monthly payment (instalment) based on the price of your new vehicle minus any upfront deposit of funds and/or trade-in value of your current vehicle. The bank will buy the car on your behalf and you will need to pay the bank back each month, including interest.
The dealership’s staff will help you to complete a vehicle-finance application. You will need to provide proof of sufficient monthly income (once your other expenses have been deducted) and your credit score will be a MAJOR factor in whether banks approve or decline your finance application. At the moment (2021) only 30% of car-finance applications are being approved. That means 70% are getting declined; your dream of owning a car might also disappear! If you want to buy a car, you need to know your credit score and look after it! How do you do this?
Read first: What is a Credit Score and why is it important?
If you put a cash deposit down against the loan, you will effectively reduce the size of the vehicle finance agreement and, therefore, the monthly repayment/instalment. You will also pay less in interest over the term of the car loan. Deposits are like “low-fat ice cream” – always healthier!
Car Finance with a Residual or Balloon
A balloon or residual payment refers to a portion of the car loan – the balloon amount – which is payable at the end of the repayment period. Many car finance providers offer this option as it allows you to pay a much lower monthly instalment. Paying less each month on your vehicle finance sounds good, but residuals/balloons increase the total cost of the car finance and you need to be able to afford to pay the balloon at the end of the term to own the car outright (be the owner and titleholder). They are definitely the choc chip ice cream of car loans – tasty but sinful.
Learn More: Pros & Cons of the Balloon Payment
Vehicle Finance with Variable vs Fixed interest rates
The choice between a variable and a fixed interest rate depends on whether you’re willing to allow market forces to affect your instalments or whether you want the certainty of preset (slightly higher) monthly payments. Variable interest rates are linked to the “prime” lending rate in the country, which is reviewed every 3 months by the Reserve Bank. With a variable interest rate for your car finance, your monthly payments may increase or decrease when the Reserve Bank increases or decreases the “prime” rate. If your monthly budget is tight, this can be a problem.
If you take out a loan with a “fixed” interest rate, then the bank is making a promise that the interest rate you pay will stay exactly the same – no matter what happens in the market.
Learn more: Variable vs Fixed interest rates: The Pros & Cons
Guaranteed buy-backs / Guaranteed Future Value (GFV)
GFV is becoming a more popular type of instalment-sale agreement. Any new car starts to depreciate the second you drive it off the showroom floor, but a GFV plan at least guarantees the future value of your car at the end of the contract term (normally 3 or 4 years), BUT you have to meet detailed terms and conditions regarding the vehicle condition, mileage and maintenance.
At the end of the contract, you are usually given three choices – you can:
- Enter another GFV deal and drive away in a new car,
- Settle the outstanding amount and own the vehicle, or
- Return the vehicle to the dealership and walk away.
This option is only really available for new cars and is popular for the more expensive cars. GFV plans can make luxury cars very affordable, but make sure you fully understand the fine print. Also remember that you walk away at the end of term and own nothing – even though you have paid your instalments religiously for 3 to 4 years.
A GFV vehicle loan application also requires a lender to perform a credit-score check because it is also a type of car-finance agreement. Therefore, the chances of being approved for a GFV agreement are about the same as other vehicle finance agreements. To reiterate, only 3 of 10 finance applications are successful at the moment!!
Also Read: My Vehicle Finance Application was Declined, What Now?
Leasing or ‘Rent to Own’
Leasing a vehicle is just what it says: You pay for the use of a vehicle for a set period and then return it at the end of that term. The rental agreement gives you the right to use the vehicle as your own, without ever owning it. “Rent-to-Own” or “Rent-to-Buy” is much the same, but there are some extra clauses that allow you to “purchase” the vehicle at certain stages of the contract.
Most contracts include comprehensive insurance and the installation of a tracking device in the rental agreement, which is important. If you are looking to compare the costs of leasing with the cost of financing, you should remember to include those costs in the latter for a fairer comparison.
This is a growing segment of the market, because it provides customers who have been “blacklisted” and would, therefore, not be able to secure traditional car finance, to acquire a new car. The National Credit Act does not apply to “Rent-to-Own” or lease agreements, which means that they can be offered to customers who would otherwise not qualify for finance.
Rent to Own Financing & Blacklisting
The monthly payments for lease/”Rent-to-Own” agreements can be expensive because they are aimed at “high risk” customers. However, they often offer more flexibility. Bank finance agreements are usually 72 months in duration and “balloon” payments often only make it feasible to change your car after 3-4 years. Car subscriptions are more flexible. For instance, Planet42 asks for a minimum commitment of 6 months, after which time the customer can return the car at any time for a nominal fee. Flexclub offers that the customer can return the car at any time.
“Rent-to-Own” is an expensive, but feasible, option if you are blacklisted. However, if you go this route, I suggest that you also invest the time to understand why you have a poor credit score and improve your score if at all possible… it will save you a LOT of money next time.
Also Read: How to get a good credit score for vehicle finance
Car Finance vs Personal Loans
If you can get an offer for vehicle finance from a bank then, almost always, the “terms” will be more favourable (that is to say the monthly payments will be lower) than for a personal loan. Offers for vehicle finance will generally encompass better interest rates and longer durations and can include a residual/balloon payment, all of which will reduce your monthly premium.
However, banks are usually fussy about offering a conventional instalment sale agreement on an older or lower-value vehicle. They will technically “own” (be the titleholder) of the car they finance and if you should stop paying instalments, they don’t want to repossess a vehicle of negligible value. Generally, you won’t get finance approval for a vehicle older than 10 years old.
This is where a personal loan can work well as you can loan the cash to pay the dealer for the car. In general, a dealer will not be able to help you arrange a personal loan, but a quick Google search will provide you with myriad options with online pre-approvals, which are quick and easy.