Beware of that ‘tempting’ 96-month car loan offer


Whether you’re a gas lover or a simple Joe, few things outweigh the smell of a new set of wheels.

While transportation is a major consideration for most South Africans, one need only take a quick glance at the advertising for new vehicles to realize that buying a car is more than just buying a car. to get from point A to point B. It is a question of aspiration.

Yet even for high-income South Africans, affordability can be a concern. With the economy shedding jobs and pressure on disposable income, an affordable monthly car payment is even more of a priority today than it was a few years ago. While one solution may be to settle for something cheaper or delay the purchase while saving money, another option is to extend the funding period or go for a lump sum payment.

Over the past six years, most South Africans who apply for auto financing have chosen a 72-month financing option – effectively paying for their car over six years. More recently, it is not uncommon to be offered payment terms of 84 months (seven years) or even 96 months (eight years) – a decision that can significantly reduce the monthly payment.

While long-term loans can address affordability issues, it’s also likely that when you trade in the car three or four years later, its market value may not be enough to cover your outstanding auto debt – leaving you out of your pocket for the deficit. The longer you extend the term of your loan, the longer it will take to reach a breakeven point (where the outstanding debt equals the trade-in value of the vehicle).

An example clearly demonstrates this: Suppose you buy a new vehicle for R 250,000 and borrow the entire amount (100% loan). At an interest rate of 12.5% ​​and a funding period of 72 months, the monthly payment will be approximately R4,950. If the period is extended to 96 months, the monthly payment drops to approximately R4,130 (R820 minus ). The average length of car ownership in South Africa is around four years, by which time the customer will still owe R100,830 on a 72-month loan, compared to R152,950 if the car was financed over 96 months. . At this point, a buyer who has financed the car for 96 months may find that the trade-in value is less than the outstanding loan amount and may be unable to pay off their current loan when trying to trade in their car for another vehicle. .

So where does that leave car buyers? Is a longer term loan (beyond 72 months) the way to go or not? Consider the pros and cons.

Advantages

Since these long term loans address affordability concerns, they ease the pressure on cash flow and can help buyers enter the market even on a tight budget.

With lower monthly payments, a buyer can also qualify for a larger loan, allowing them to finance a more expensive car.

The inconvenients

As mentioned earlier, the biggest downside to a longer term loan is the risk that the outstanding credit will exceed market value at the time you want to trade in the vehicle, leaving you out of pocket for the difference.

You will pay more interest over the life of the loan (all other things being equal). As the outstanding loan decreases at a reduced rate, the amount of principal on which interest payments will be calculated will be higher at the same time (for example, 10% in 100,000 R is greater than 10% in 95 000 R).

Repair costs can also become a headache. Most warranties cover 100,000 km or three years. If you finance a vehicle for 96 months, you are more likely to have to cover repair costs out of pocket after the warranty expires.

We also find that default rates increase when customers finance their vehicles for longer periods of time, which negatively affects their credit score.

The verdict

We encourage customers to finance vehicles for shorter periods. As such, we prefer not to offer customers a financing period beyond 72 months when they apply for a car loan.

While affordability is an important consideration, we strongly believe that buyers – first-time buyers and volume market buyers in particular – should finance a vehicle for 72 months or less.

It is also important to consider the impact of the lump sum payment (inflated final payment). Financing an R250,000 vehicle over 72 months with a 30% lump sum payment (12.5% ​​interest, no deposit) will reduce the monthly payment from around R4,950 to around R4,250, but will charge you a lot more. ‘interest over six years period.

By choosing something practical that suits your needs and paying it off as quickly as possible, you can save a lot of money over time, especially during these tough economic conditions that we face as a country.

This approach can have a significant impact on your overall financial health and will be especially helpful to long-term first-time buyers.

Faisel Mkhize is the Managing Director of Vehicle and Asset Finance, Retail and Business Banking, Absa Group.

The views and opinions shared in this article are owned by their author, should not be construed as financial advice, and do not necessarily reflect the views and opinions of Moneyweb.

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