Steering clear of the debt pothole

22 July 2014 - 12:45 By IgnitionLive Reporter
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KEEP SMILING: By buying with your head, not your heart
KEEP SMILING: By buying with your head, not your heart

First-time car buyers might be tempted by the many models on offer on both the new- and used-car showroom floors - but they need to avoid the giant pothole created by debt.

According to the latest data from finance provider WesBank, more and more buyers are opting for finance structures that lower their monthly repayments - but cost them more in the end.

These instalment plans include large balloon payments - also known as residuals - and also take advantage of the longer repayment periods that banks started offering once the National Credit Act was implemented.

Rudolf Mahoney, head of research at WesBank, said: "Consumers should resist the urge to splash out and get a vehicle that is not in their price range."

When the credit act was introduced in June 2007, demand for balloon payments plummeted and buyers chose longer contract periods to help reduce monthly repayments. Since then, however, demand for balloon payments has grown by 60%, and now one in every five finance deals includes one.

In 2007, WesBank's average contract period was 54 months - now the average is 68 months.

Mahoney said: "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."

WesBank has three simple tips for saving money in the long run:

1:Avoid balloon payments.

A residual of 20% on a vehicle of R240000 will require monthly instalments of R4739.58 (over 60 months, at 11.5% interest). At the end of the finance term the buyer will have paid R284374.84, but will still owe a 20% balloon payment - or R48000. So, in the end, the vehicle would have cost a total of R332374.84.

Furthermore, if the owner trades in the vehicle, the outstanding balloon amount will be subtracted from the trade-in price. And if the owner chooses to keep the vehicle, he may finance the outstanding amount, thus incurring more costs.

For a finance deal with no balloon payment, the monthly instalment would be R5335.23 (over 60 months at 11.5% interest), resulting in a total repayment of R320113.55 - or R12261.29 less than the deal with a balloon payment.

2:Opt for the shortest possible repayment period.

The same R240000 vehicle financed at 11.5% interest over 72 months will require monthly repayments of R4686.88 - and end up costing a total of R337455.18.

But a 54-month contract will save the buyer R25821.80, with monthly repayments of R5770.99.

And buyers on lengthier contracts will have to wait longer before the outstanding financed amount is less than the vehicle's market value.

3: Pay more upfront.

This reduces the loan amount, the buyer will pay less in interest and the monthly repayments will be smaller.

Mahoney said that by saving money on financing, consumers would be in a "better position when it comes to purchasing another vehicle down the line".

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