Vehicle finance: What to know about your financing options

Two men shaking hands in front of vehicle

Despite shrinking disposable consumer income and a weak economy, year-on-year new vehicle sales have increased by 10.1% since last year, with 90.2% of these sales been made by vehicle dealerships. If you’re planning to buy a new car, it’s important to understand the process and the various financing options available. Here’s what to know:

  1. The affordability calculator is a useful guide

When it comes to understanding the costs of financing a vehicle, it is important to take into account those costs over and above the monthly repayments, including comprehensive insurance premiums, maintenance, repairs, fuel, tyres, services, licensing, traffic fines, and parking. Before buying a new car, or trading in your current car, it is always advisable to use an affordability calculator – with most financing institutions providing useful online tools. That said, keep in mind that the affordability calculator doesn’t have insight into your overall financial position and should merely be used as a guide to determine what financing you’re likely to qualify for.

  1. You’re likely to be quoted the monthly instalment amount and not the actual price of the car

When buying from a dealership, you’re likely to be quoted on the monthly repayments rather than the actual purchase price of the card. This is because car salespeople understand that, for many, the ability to afford the monthly repayments is more important that knowing the actual cost of the vehicle over the term of the contract. Dealerships have substantial flexibility when it comes to tailor-making a finance package that meets your monthly budget and, because of this, many people end up buying cars that they actually cannot afford.

  1. The instalment sale agreement is the most common form of vehicle purchase arrangement

When it comes to financing a car, the Instalment Sale is the most common type of agreement, which is effectively an agreement between you and your bank that enables you to take delivery of the car while you pay back the loan over a pre-determined period of time. Most vehicle financing institutions offer a minimum financing period of 12 months up to a maximum of 72 months. Naturally, the longer your vehicle finance term, the lower your monthly repayments will be, although you will ultimately pay more interest. On the other hand, a shorter financing period will result in higher monthly repayments, but you will save on interest. Generally speaking, banks do not offer financing on vehicles older than ten years, except in the case of vintage and/or classic vehicles. 

  1. Your credit score matters

Although it is important to shop around for the most favourable financing package, all banks take the same factors into account, with their finance products being fairly similar. In many instances, it boils down to which financing institution is easier to do business with in terms of providing a seamless, swift transaction. Each application for vehicle finance is considered on an individual basis, taking into account your credit record, risk profile, the size of the loan, and repayment history on previous loans. As such, your credit record plays an important role in determining whether you qualify for a loan – and the better your score, the lower the risk you present to the financing institution and the more favourable your interest rates are likely to be.

  1. You may be required to pay a deposit

Depending on your risk, your financing institution may require that you pay a deposit. The bigger the deposit you put down on your vehicle, the less risk you present to the financial institution you are borrowing from which should result in a smaller monthly repayment and a lower interest rate. 

  1. Monthly repayments on a fixed rate are generally higher

If you choose a fixed interest rate, you will be charged the same interest rate for the duration of your financing agreement, regardless of whether prime interest fluctuates or not. This means that your monthly repayments will stay the same and you won’t have any unpleasant surprises when interest rates rise. If you’ve linked your interest to the prime lending rate, your monthly repayment will fluctuate in line with interest changes. While this can protect you from the downside, if interest rates fall you will not benefit from the rate decrease. Monthly repayments on a fixed rate are generally higher than those of a linked rate as the risk of any rate change is borne by the financing institution.

  1. Balloon payment options will make the vehicle appear more affordable

In order to make a vehicle more affordable on a monthly basis, many dealerships structure financing agreements which include a balloon payment, or residual value, at the end of the contract term. A balloon payment is where a percentage of the vehicle’s value is taken off the financed amount, with this balloon or residual amount becoming payable as a lump sum at the end of the financing period. While this has the effect of lowering your monthly repayments – thereby making the vehicle appear more ‘affordable’ – you still pay interest on the residual amount and will need to ensure that you have a capital amount available at the end of the contract or risk having to sell your car. Another option is to re-finance the vehicle, but this will cost you even more in the long term and can result in you entering a cycle of debt that is difficult to extract yourself from. The structuring of balloon payments makes even hugely expensive vehicles accessible to anyone.

  1. A full maintenance lease means you never actually own the car

A Full Maintenance Lease is a form of financing where you effectively lease the vehicle for an agreed period of time in exchange for a monthly fee or rental. This fee covers all costs including maintenance, service, tyres, oil filters and wiper blades. After the rental term, you are required to hand back the car and replace it with a new one. The monthly repayments for a Full Maintenance Lease are lower than an Instalment Sale and there are no nasty residual payments at the end of the term. However, you never actually own the vehicle and there are strict limits on the distance you are allowed to travel, with penalties for excessive mileage.

  1. You will need to factor the costs of insurance into your affordability calculations

If you’re financing your vehicle, you will be required to provide proof of comprehensive insurance but remember that you are free to insure the vehicle through your own insurer and are not required to make use of the bank’s insurer. Also keep in mind that drivers between the age of 18 and 25 are considered high risk by most insurance companies, which means that your premiums are likely to be higher – although there are steps you can take to bring your premiums down. One option is to do a defensive driving course which will reduce your risk. Keep in mind that the insurer will take into account the type of car you drive, with more powerful cars attracting higher premiums. It also helps to have your insurance policy in your name as soon as possible so that you can start building up a no-claims driving history.

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